New dollar bond market to help fund M&A deals

A new Chinese market for dollar-denominated bonds issued by non-financial firms, due to be launched soon, will create a key new source of funds for companies looking to invest abroad or acquire foreign firms.

The market, which analysts estimate at $30 billion in issuance during the next one to two quarters, will offer a new investment channel to Chinese investors who may have grown wary during the global financial crisis of buying foreign-currency bonds issued abroad.

It will also bolster an official campaign urging corporate China to venture abroad and make acquisitions.

China National Petroleum Corp, the nation's biggest oil company, has started registering for dollar-denominated bond issuance of up to $3 billion and plans to auction $1 billion of three-year floating-rate debt in the interbank market soon, banking sources said.

The auction would mark the start of a new domestic market for dollar-denominated bonds of non-financial institutions.

"The new market is expected to allow Chinese companies to raise money via dollar bond issues to acquire resource assets abroad," said Xu Jian, analyst at China International Capital Corp.

The government is also eager to develop a dollar bond market that could complement drains by the People's Bank of China in open market operations, in response to an expected rise in capital inflows from abroad later this year as the economy and asset markets pick up.

"Having CNPC shoulder some of the sterilization burden is a win-win. It advances the PBOC's long-run goal of de-emphasizing the US dollar as a reserve currency. And it provides US dollar funding for CNPC," ING said in a research note.

Shi Lei, an analyst at Bank of China, estimates that non-financial Chinese firms will issue about $30 billion of dollar-denominated bonds in the next quarter or two for investment overseas.

That amount would just about cover the $22.4 billion pipeline of outbound M&A deals by Chinese companies that have been announced this year but have not yet been completed, plus another $9.7 billion of still-pending deals that were announced in the previous three years, according to Thomson Reuters data.

Chinese corporations are expected to be willing issuers of dollar bonds, with dollar funding costs at rock-bottom levels since early this year as the US currency's global strength during the financial crisis has erased expectations of near-term yuan appreciation against the dollar.

Traders expect CNPC to pay a coupon of about 60 to 70 basis points over London Interbank Offered Rates, a lower cost than the 2.8 percent issue yield for its 20 billion yuan ($2.93 billion) in yuan-denominated three-year fixed-rate medium-term bills issued in December.

Companies would have had to issue dollar bonds at high yields last year, when dollar funding costs were high amid strong yuan appreciation. "Now they will be very willing to issue dollar bonds since the issue yield will be low," said a trader at a securities company in Shanghai.

In China, six-month dollars were quoted around 0.4 percent early this year and remain below 1 percent, traders said, in line with the rate implied by onshore dollar/yuan forwards of less than 0.3 percent early this year and around 0.8 percent currently. The six-month implied forwards rate hit a multi-year high above 15 percent in March 2008.

China's decision in August to ease rules governing its foreign exchange system for the first time in 11 years helped to pave the way for the launch of a domestic dollar bond market.

The new rules allowed companies to retain foreign exchange income offshore and onshore if they wished, creating potential demand for dollar investment.

Previously, they were required to sell their foreign exchange income to designated Chinese banks or deposit it in accounts at those banks.

A sudden burst of dollar bond issues, however, is unlikely. Protectionist measures may hinder outbound investment growth and the demand for dollars to finance them.

The limited liquidity of the newly launched asset will also inhibit investor participation in the market in the early stages, analysts said.

Reuters

(China Daily 04/27/2009 page4)