The index of government bonds traded on the Shanghai Stock Exchange has slipped 6.63 percent since the start of the year amid concerns that the Chinese central bank might raise interest rate to cool excess investment and rein in rising inflation.

Even though the index edged up 0.40 percent to 92.80 Monday, it was drop from last year's closing of 99.39. The index fell to this year's low of 91.90 on April 30.

"The expectation of the hike in the interest rate has dampened the sentiment on the bond market," said Wei Wei, a trader with West China Securities Co Ltd. "Things will not change until the release of the second-quarter economic data when the government will gauge whether its previous tighter measures are effective and decide if tougher measures are needed."

A rise in the interest rate makes the fixed payment of bonds less attractive.

The benchmark seven-year bond maturing in 2010 slid 6.85 percent from the beginning of this year to 89.70 yuan (US$10.81) Monday, boosting its yield to 4.74 percent from 2.76 percent at the start of the year.

The Chinese government has raised the amount of cash commercial banks must set aside as reserves at the central bank thrice over the past seven months. It has also ordered lending to overheated sectors, such as steelmaking and light industry, be stopped to cool the economy which grew 9.7 percent for the first quarter.

But these measures might not be working well as inflation accelerated to 3.8 percent in April from the year-ago period and the fixed-asset investment rose 43 percent in the first quarter.

Analysts expect inflation to continue its rise, which will jeopardize the 3 percent annual target set by the government.

The consumer price index, a gauge of inflation, is likely to rise 4.5 percent this month year-on-year and 5.8 percent in June, according to Qu Hongbin, an economist at HSBC Holdings Plc in Hong Kong.

"This means that the People's Bank of China is likely to increase the managed lending rate (one-year benchmark lending rate is 5.3 percent) before early July," Qu wrote in a research note. "We expect the first rise to be around 50 basis points." One basis point is 0.01 percentage point.

The bond market is poised for a further decline due to the introduction of short sales on Friday, said CITIC Securities Co Ltd in an analysis report.

Short sales will cause a decline as short sellers make profits by selling bonds at a higher price and then buying them back at a lower price before the maturity date of the bonds.

The abolition of the rule on June 1 requiring mutual funds to invest a minimum 20 percent of assets in bonds is also negative for the bond market.

"As a result, fund management companies will very likely reduce their bond portfolios," said the report.

CITIC Securities recommends that investors shun long-term bonds due to the uncertainty over the rise in the interest rate.

(eastday.com May 18, 2004)