New Era of Higher Costs Spurs Record 50-Year Yield: China Credit

New Era of Higher Costs Spurs Record 50-Year Yield: China Credit

China sold 50-year bonds at a record high yield as banks prepare for what they describe as a new era of higher borrowing costs after a government policy overhaul. The finance ministry auctioned 20 billion yuan ($3.3 billion) of debt due November 2063 on Nov. 15 at a yield of 5.31 percent, the highest since sales of the tenor began in 2009. That compares with a 4.24 percent rate offered in the previous sale and the 5.05 percent median estimate in a Bloomberg News survey. The sale drew bids for 1.51 times the amount offered, less than the 2.13 times in May.The People’s Bank of China in July scrapped a floor on lending rates and Deutsche Bank AG in September forecast the cap on saving rates will end by 2015, a move that would spur competition for deposits among the nation’s more than 3,700 banks. Market forces will be “decisive” in allocating resources, according to a communique released after a four-day economic planning meeting attended by Chinese leaders.

“We should probably adapt to a new era as the old times of cheap money are behind us,” said Cheng Qingsheng, a Shanghai-based analyst at Evergrowing Bank Co. In recent weeks, “a lot of sovereign and financial bonds were issued, and the PBOC drained money.”

President Xi Jinping is accelerating an unwinding of Communist Party economic policies that originated during or shortly after the reign of Chairman Mao Zedong.

Easing Controls

The leadership meeting decided to expand farmers’ land rights, loosen the one-child policy and encourage private investment in state businesses. Farmers will get more rights over collectively owned rural land, while the household registration system that impedes internal migration will be scrapped in towns and small cities, the Communist Party said in a statement on Nov. 15.

The nation will accelerate convertibility of the yuan and the freeing-up of interest rates, improve treasury yield curves and let qualified private investors set up small-to-medium sized banks, according to the decision.

China started publishing a new prime loan rate based on quotes from banks in October and signaled it may eventually replace the current benchmark set by the PBOC. Trading of certificates of deposit between lenders will be permitted in the “near term” to create conditions for steady and orderly promotion of deposit-rate liberalization, Hu Xiaolian, a PBOC deputy governor, said on Sept. 24.

More Choices

Commercial banks held 69 percent of outstanding government bonds at the end of 2012, according to China Financial Futures Exchange data. In January 2012, the finance ministry published a list of 59 underwriters that were mandated to bid at its debt sales, including Industrial & Commercial Bank of China Ltd., Agricultural Bank of China Ltd., Bank of China Ltd. and China Construction Bank Co.

Demand for longer-term bonds is driven by investors such as insurance companies, and the low bid-to-cover ratio at the finance ministry’s sale last week could be because these funds now have wider choices, according to Guotai Junan Securities Co. China allowed insurers to invest in hybrid bonds and convertible debt and raised the investment ceiling for unsecured notes last year, according to a statement on the China Insurance Regulatory Commission’s website.

“The wider investment scope allows insurers to seek alternatives to long-term debt,” said Min Shuai, a Shanghai-based analyst at Guotai Junan. “There is a lack of demand from insurers.”

Aging Population

The number of people in China aged 60 or above will rise to more than 300 million by 2025 from 194 million in 2012, according to a State Council report in September. An increasing fiscal burden caused by the aging population is forcing the government to reduce some implicit sovereign guarantees, Standard Chartered Plc analyst Dorris Chen wrote in an Aug. 8 note to clients.

“We have predicted for several years that China will need a well-developed bond market by 2017,” said David Munro, chief executive officer of Volatility Research & Trading Ltd., a Singapore-based company that advises hedge funds and companies on risk management, derivatives and demographics. “This is to meet the demand of aging or retiring Chinese from a baby boom in the 1960s for risk-free investments with a yield. China recognizes this and is providing what the population needs.”

Economic Transformation

The nation is pushing a shift of the economy to one that is driven by sustainable, domestic consumption rather than exports. Growth is entering a phase of transformation involving a slowing down from “high speed to medium-to-high speed,” Premier Li Keqiang said in September. He has also signaled that the government’s bottom line for expansion is 7 percent, the level needed to meet the Communist Party’s target of doubling per capita income in the decade through 2020.

Benchmark money-market rates jumped the most in almost five months on Nov. 15 as the PBOC drained cash from the financial system for the second straight week. The central bank’s money-market operations withdrew a net 15 billion yuan last week, according to data compiled by Bloomberg, while a Founder Securities Co. report said the Ministry of Finance and policy banks issued about 100 billion yuan of bonds.

The seven-day repurchase rate, a gauge of funding availability in the banking system. rose 25 basis points this month to 5.3 percent on Nov. 15 in Shanghai. The yield on the government’s 10-year sovereign bonds advanced 42 basis points to 4.6 percent in the same period, according to Chinabond data. That was the highest since 2008. The yuan, which has gained 2.3 percent this year, rose 0.01 percent to 6.0917 per dollar as of 11:01 a.m. in Shanghai today.

“People may buy if they see trading opportunities, but no one really wants to add long-duration bonds to their portfolio under the current circumstances,” said Sun Binbin, a bond analyst at China Merchants Securities Co. in Shanghai. “China’s interest rates have been artificially kept low in the past, and now we’re witnessing the process of normalization.”

To contact Bloomberg News staff for this story: Fion Li in Hong Kong at fli59@bloomberg.net; Helen Sun in Shanghai at hsun30@bloomberg.net