Mainland Investment Agency Financing Bond Set for Issue

The first batch of special bonds to finance the mainland's investment agency might be issued as early as next week, paving the way for the long-awaited launch of the China Investment Corp, the Securities Daily reported yesterday.

The Agricultural Bank of China initially would buy the bonds from the Ministry of Finance on behalf of the central bank, which is banned from purchasing the coupons directly, the newspaper said, citing an unnamed bank source.

"The first 600 billion yuan of special treasury bonds is expected to be issued to the Agricultural Bank of China next Wednesday or Friday, and the central bank will then use its foreign exchange reserves to buy back the bonds," the report said.

Reports had suggested the mainland's cash-rich insurers might also buy the bonds. Agricultural Bank could not be contacted yesterday.

The tranche is part of the 1.55 trillion yuan worth of special treasury bonds that the ministry will issue to buy US$200 billion of the country's massive foreign exchange reserves from the People's Bank of China to seed the state investment agency.

As in many countries, the central bank - the repository of the mainland's foreign reserves - is banned from buying government bonds directly to prevent it from being used to finance government debt.

The investment firm is being created to seek better returns for the foreign reserves - which hit US$1.33 trillion at the end of June - by investing in a wider array of assets than low-yielding US Treasury notes and other government bonds.

It has been reported that the special bonds would be issued in two batches of 600 billion yuan and one tranche of 350 billion yuan.

Analysts said doubts remained about the intricacies of the financing arrangements made between different government departments and Agricultural Bank.

In practice, the country's fourth-largest lender may simply channel foreign exchange from the central bank to the investment corporation.

Alternatively, the bank might pay for the bonds itself with yuan and then sell them on to the central bank, forcing the ministry to then exchange the local currency into dollars in a separate transaction.

"There may be a difference between who on paper is buying the bonds and the real money flow," said Charlene Chu, director of financial institutions at Fitch Ratings.

However, since the bonds are directed to the central bank, they are likely to end up back in the hands of commercial lenders as part of the People's Bank of China's regular mop-up of excess liquidity in the domestic economy, according to a person at one of the foreign investment banks advising the corporation.

He said last month's spike in the broad money supply to 18.5 per cent from 17.1 per cent in June may have come after the central bank sterilised less money than normal in the expectation that it would have the special bonds in July with which to do the job.

Instead, the bond issue was delayed by a power struggle between the central bank and the ministry over who would have effective control over the agency, which is supposed to be independent.

The bond issuance mechanism was "simply designed to transfer the foreign exchange from the People's Bank of China to CIC", said James McCormack, head of Asia sovereigns at Fitch Ratings.