Thursday, June 28, 2007

Well, the NPC approved the 1.55 trillion RMB float of bonds to buy 200 billion USD from the foreign exchange reserve for investment, the first of which--the Blackstone share acquisition-- is already making a huge nominal profit. However, the challenge to make the forex fund profitable will be quite formidable in the future. Bond yield is currently 4.4%, and this large float might push it up toward 5%. At the same time, the RMB is revaluating at an annual rate of between 3-5% vis a vis the dollar. This means that if the fund is to make money, it would have to generate net profit of between 7.4% and 9.4%. I am no investment expert, but it sounds like a tough thing to do when you are managing 200 billion dollars. But then, if the fund loses a few billions here and there, I don't think the Chinese government would bat an eye.

China Plans Bonds for New Agency

June 28, 2007

BEIJING -- China plans to capitalize its new foreign-exchange-investment agency by issuing a local-currency bond valued at more than $200 billion, clearing a key hurdle for the sovereign-investment fund that will be formally established in coming months.

Chinese Finance Minister Jin Renqing said the fund will invest in overseas industries and financial products.

The issue, which equals about a third of total outstanding government treasury debt, will also help China absorb liquidity in its financial system and help it develop a longer-term yield curve, said Mr. Jin, according to the official Xinhua news agency.

China's Finance Ministry plans to issue 1.55 trillion yuan ($203.5 billion) in tradable bonds with maturities of at least 10 years in order to buy about $200 billion in foreign exchange, the official Xinhua news agency said. The Standing Committee of the National People's Congress began reviewing the proposal yesterday and is likely to approve the plan this week.

Economists have said the massive bond issue will boost liquidity in long-term government bonds and build a better yield curve for traders to price debt, helping the country develop its nascent bond market. The new bonds could also serve another useful purpose for China -- draining liquidity from a financial system awash with funds.

The plan was set "in accordance with the trend of growth in foreign-exchange reserves and the need to carry out monetary policy," Mr. Jin told legislators, according to Xinhua. He added that China still has excess liquidity, which exerts some inflationary pressure.

"The Finance Ministry's special bond issuance for buying forex could drain money from the money market, while providing the People's Bank of China with an effective monetary policy tool," Xinhua cited him as saying. "It would help ease pressure on the PBOC for sterilization, and ease the problem of excess liquidity. Sterilization is a process in which the central bank issues bills to absorb liquidity from the interbank market.

Mr. Jin also said the longer maturity period for the special bonds would help build a better yield curve and "deep-freeze" excess liquidity.

HSBC Chief China Economist Qu Hongbin estimates that if the entire amount of bonds were issued directly to markets, it would withdraw the same amount of liquidity as 10 increases in banks' reserve ratio requirements by 0.5 percentage point.

On the fund's investments, Mr. Jin said: "The rate of returns must be higher than the interest on the special bonds." He didn't say in the Xinhua reports if the fund's industrial investment would involve buying commodities, such as oil, or stakes in companies.

Economists said they expect Beijing to try to temper most of the issue's macroeconomic impact by having the central bank retire shorter maturity bonds and having the Finance Ministry replace them with longer-term bonds.

"In the short term, this has to be incredibly well coordinated for it to work," said Stephen Green, a senior economist at Standard Chartered Bank in Shanghai.

Yields on the Finance Ministry's bonds will be "set flexibly according to market conditions," Xinhua said.

The capitalization plan brings the agency, which doesn't yet have its own office, closer to becoming a legally established entity and making further investments.

The foreign-exchange-investment agency, tentatively called the State Investment Company, began taking shape in February, with a mandate to earn a higher return on a portion of China's $1.2 trillion in foreign-exchange reserves.

Lou Jiwei, a former vice finance minister heading the agency, has already made a bold step by taking a $3 billion stake in U.S. private-equity firm Blackstone Group's initial public offering.

--Terence Poon and Wang Ming contributed to this article

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