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Euro bond issue shortens odds on loosening of peg

Expect a big yen issue next, but don't hold your breath waiting for it. And even further down the track (where the going gets decidedly sticky), there might be a dismount from a US dollar currency peg to a peg against a broader basket of currencies.

That's the odds-on betting from market watchers to news that China embarked this week on a European roadshow to promote a landmark euro bond issue.

At Euro1 billion (HK$9.59 billion), the 10-year notes will be the biggest and longest-dated issue ever from an Asian government, and will be the senior tranche grabbing the headlines in a US$1.7 billion capital raising - with the balance coming from a US$500 million five-year greenback issue.

Stacked up against total official foreign-exchange reserves of US$470.6 billion, the euro proceeds from the issue will barely alter the present portfolio mix of China's foreign-currency assets, which is heavily skewed in favour of US dollars.

Latest United States data shows China is the second-largest holder of US treasuries, valued at US$166.9 billion as of July. But it is the third and boldest euro issue from the government in addition to being the longest-dated, and follows a five-year Euro400 million bond sale last year and a pioneering Euro550 million four-year sale in 2002.

That begins to look like a calculated effort to begin diversifying out of US dollar assets and into the other major currencies, which would be a logical precursor to changing the currency peg.

Based on that logic, expect more yen issues, and - as a real long-odds prospect (if big brother can be enjoined to help the EMEAP Asian Bond initiative) - perhaps even a regional-currency issue?

Given China's substantial reserves, it is plain that policy, rather than a need for money in any denomination, lies behind the latest issue.

And as a member of EMEAP (the 11-member Executives' Meeting of East Asia and Pacific Central Banks), China has, after all, thrown its weight behind a campaign to promote Asian-currency bonds.

A more immediate and realistic policy behind the latest issue, however, includes the obvious and sensible desire to build a benchmark yield-curve against which prospective longer-dated China corporate issues may be priced.

Expect more of those, too.

Meanwhile, on the currency front, whatever route China eventually takes to altering the present peg and allowing the yuan to revalue, such an outcome is becoming increasingly likely as the benefits of doing so become clearer.

To mention just two: a stronger yuan will mean cheaper imports, which will slow import inflation. It will also raise the hurdle for investment inflows, which would enforce greater discipline since it will mean that only those projects guaranteed to deliver the higher returns required to justify the higher entry costs will be pursued.

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