SHANGHAI, June 30 (Reuters) - Foreign companies are issuing local currency bonds in China at record pace, lured by lower borrowing costs and government incentives aimed at promoting global use of the yuan.

Issuance of so-called panda bonds by offshore borrowers such as Mercedes-Benz and Deutsche Bank in China's interbank market totaled roughly 66.9 billion yuan ($9.23 billion) in the first half, a record for the period, official data shows.

The frenzy was partly driven by Sino-U.S. monetary policy divergence that has made "onshore funding costs more attractive," said Shuncheng Zhang, Associate Director of China Corporate Research, Fitch Ratings.

In addition, Beijing has streamlined the issuance process of such bonds and encouraged more flexible use of proceeds as part of efforts to open up China's bond market, Zhang said, expecting panda bond issuance to remain solid in the second half.

China has been cutting interest rates to spur a flagging post-COVID recovery, while the U.S. and Europe are doing the opposite to combat runaway inflation. The yield gap between 10-year U.S. and Chinese treasuries exceeded 118 basis points this month, the widest since November.

Lower interest rates in China are also fuelling a jump in other yuan bond issuance, including in Hong Kong's "dim sum" bond market, and Shanghai's "pearl bond" market.

Fitch's Zhang cautioned that yuan volatility could create headwinds for the panda bond market "as hedging costs could concern issuers that plan to convert their issuance proceeds into foreign currencies."

The yuan has fallen to seven-month lows against the dollar this month amid worries about China's economic health.

Rocky Fan, economist at Guolian Securities, said that companies are inclined to borrow yuan when it's falling, and they can also capitalize on the yield difference.

"It can be seen as a way to arbitrage, leveraging the interest rate differential," he said.

One benefit of a prosperous panda bond market is that it helps yuan globalization.

Last year, Beijing relaxed rules to make panda bond issuance easier. One major change is that issuers can choose to spend the proceeds in China or repatriate them to other countries.

($1 = 7.2519 Chinese yuan renminbi) (Reporting by Li Gu and Samuel Shen in Shanghai; Tom Westbrook in Singapore; Editing by Emma Rumney)