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China Aims for U.S.-Level Yields in $2 Billion Bond Offering

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10/25/2017 | 02:39am CET
By Manju Dalal and Carolyn Cui 

China is returning to international bond markets for the first time in 13 years, with a $2 billion offering of U.S. dollar bonds that will allow the world's second-largest economy to flex its financial muscle in the wake of its just completed Communist Party Congress.

Bankers have begun marketing China's five- and 10-year bonds to investors, primarily in Asia and Europe, and the securities are expected to price on Thursday. China's Ministry of Finance is scheduled to hold a conference call on Wednesday with potential investors to take questions about the deal.

Investors from China and elsewhere are eager to buy the country's sovereign bonds, reflecting the demand that has helped drive booming global debt issuance this year. Potential investors and analysts believe a successful sale could bring yields on the Chinese bonds down to levels close to yields that prevail for the U.S., a major milestone for a developing economy.

"There will be a lot of demand for China's bonds," said Ken Hu, chief investment officer of Asian fixed-income investments at Invesco Asset Management in Hong Kong. He said the offering is small by the standards of the U.S. and other major sovereign issuers, likely creating a scarcity value for Chinese securities that will push up their price and reduce yields.

Many institutional investors in China are looking to invest in U.S. dollar assets and few see the country carrying any significant default risk, in part because of its relatively low level of external debt.

A successful offering stands to reduce borrowing costs for the state-backed companies that are the backbone of China's economy, analysts and investors said. At the same time, economists warn that Chinese corporate debt levels have risen sharply in recent years and that its state-backed firms are in need of an overhaul to increase efficiency and reduce malinvestment.

China isn't borrowing in U.S. dollars because it needs the money. To the contrary, China routinely runs a trade surplus, exporting more than it imports, and holds some $3 trillion in foreign-currency reserves, including a large hoard of U.S. Treasurys.

The bond sale will be a test of how global investors perceive the country's economic and financial health, following a slowdown in growth and credit-rating downgrades earlier this year. China's economy expanded 6.8% in the third quarter, but its outlook appears hazier due to its reliance on old-line manufacturing industries and rising corporate debt levels.

Still, strong investor demand could push down yields on China's new bonds to less than 0.3 percentage point above comparable Treasury yields, estimate several money managers and analysts. The yield on the five-year U.S. Treasury note was recently 2.027% and the 10-year Treasury yield was 2.406%.

Buyers are expected to include Chinese banks and other domestic investors looking to invest money offshore, as well as sovereign-wealth funds and Western money managers. The securities may be also be added to global bond indexes, making them more attractive to investors.

If the sovereign deal is oversubscribed, Beijing would tout the success as a sign of "international investors' endorsement of President Xi Jinping's economic visions for China and his leadership," said David Loevinger, a managing director of emerging-markets sovereign research at TCW Group Inc.

U.S.-based credit raters Moody's Investors Service and S&P Global lowered China's credit rating to the equivalent of A+ in May and September respectively, ranking China's creditworthiness three or four notches below that of the U.S. Both firms said their downgrades were rooted in what they felt were rising economic and financial risks in China.

The actions drew the ire of China's government, which accused the rating firms of misreading the country's economy. In a statement Tuesday, China's Ministry of Finance said the economy is stable and gathering momentum, and it questioned the credibility of the international rating firms. It said professional investors would make an "objective judgment" on China's credit risk. China's new sovereign bonds will be unrated, according to one of the banks involved in the sale.

In recent months, so-called spreads -- a measure of how much investors are being compensated for risk -- on outstanding U.S. dollar debt issued by Chinese companies has fallen sharply to multiyear lows, according to data from Bank of America Merrill Lynch. In the credit-derivatives market, the cost of buying insurance against a Chinese default has also plunged.

If China's bonds price below sovereign debt issued by South Korea earlier this year, they could set a record for Asian bonds. South Korea in January sold $1 billion in 10-year dollar bonds with a 2.75% coupon. Those securities were priced to yield 0.55 percentage point over comparable Treasurys. Korea has a AA rating from S&P, two notches above China's rating, and its U.S. dollar bonds have the lowest spreads above Treasurys in the region.

"Pricing on [China's] bonds is going to be inflated by demand from Chinese banks...so it's possible they could be even tighter than many market participants expect," said Richard Briggs, an analyst with CreditSights in London.

China last sold U.S. dollar bonds in 2004; that year, its 5-year debt priced to yield 0.6 percentage point over U.S. Treasurys. At the time, the country's credit rating was lower than what it is now.

Graham Stock, a senior sovereign strategist at London-based BlueBay Asset Management, a fixed-income firm with $57 billion of assets under management, said that the firm is interested in the new bonds, but it "all depends on the pricing."

"There's appetite for getting exposure to China, in part because this is a very rare sovereign deal," he said. If spreads come in too tight, however, some foreign investors may decide they aren't being compensated enough and will instead look for other investing opportunities in the region.

China has lined up 10 underwriters, including four foreign banks, to drum up investor interest in the bonds. They include Citigroup Inc., Deutsche Bank AG, HSBC Holdings PLC and Standard Chartered PLC, along with the Bank of China and other large Chinese banks.

--Yifan Xie contributed to this article.

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