The rise in yield and expectations of increased supply have combined to push down prices of the newly issued local government bonds, raising the cost for prospective issuers.]

Local gov't bond issuers may tweak coupon rates [CFP]

Since March, China's Ministry of Finance (MOF) has issued eight bonds on behalf of local governments, with the coupon rates rising about 20 basis points.

The latest bond issued by Shandong province carried a coupon rate of 1.8 percent per year, up from 1.61 percent for the first such bonds issued by the Xinjiang Uygur autonomous region.

Trading in local government bonds have been sluggish and the prices of several of them have fallen below their par value.

"Potential buyers of local government bonds, mainly banks, are staying on the sideline because of the upward pressure on market yields," said Wang Yang, co-head of fixed income research with UBS Securities. As a result, the market becomes even more illiquid, which, in turn, is keeping investors away, he explained.

New issuers must therefore raise the coupon rate to entice investors. "In primary market, the coupon rate that's 5 to 10 basis points above Treasuries could be attractive to investors, especially the commercial banks," Wang added.

The coupon rate of central government bonds is currently about 3.73 percent, and the fixed rate of three-year deposits is about 3.33 percent.

China plans to float 200 billion yuan of local government bonds this year. In the initial stage, eight local government bonds that have been issued raised 35.4 billion yuan.

In the second half of this month, another 31 billion yuan of such bonds will be on the pipeline for issuance, involved eight regions, including Jiangsu and Hubei provinces.

"The government will further enlarge local government bonds' proportion in the financial system and build up a reliable risk control mechanism," said Jia Kang, head of the research institute of financial science under the Ministry of Finance.

Analysts in private sector institutions agreed. "Local government bonds are a relatively new phenomenon in China. If successfully managed, these bonds could prove to be an effective fund-raising vehicle for local governments and offer investors additional opportunities to participate in China's development," said Jing Ulrich, managing director and chairwoman of China Equities with JP Morgan.

Of the 200 billion yuan in local government bonds, Sichuan province received the largest share with 18 billion yuan, followed by Guangdong province with about 11 billon yuan.

(China Daily April 17, 2009)