Danger warning on China debt
The Chinese Government's proposed issue of Hong Kong dollar-denominated bonds in Hong Kong could have an unpredictable and possibly adverse effect on the territory's monetary system, particularly on interest rates, capital market sources say.
Hong Kong Monetary Authority Chief Executive Joseph Yam Chi-kwong yesterday said he had reservations about the plan.
'China's plan may have a negative impact on the pricing of the exchange fund papers we are issuing,' he said.
The authority would study the idea from the perspective of the pricing of the paper, tax treatment and the settlement.
Last week, China's deputy finance minister Liu Jibin said in Beijing the mainland would issue Hong Kong dollar-denominated bonds to support the territory's securities market when conditions were ripe.
Capital markets sources say difficulties in pricing would be the main hurdle.
The existing interest rate differential between exchange fund debt securities and those issued by China's Ministry of Finance (MOF) was so big it would trigger a big shift to the MOF paper.
The MOF's cost of borrowing in international markets is well above what the Hong Kong Government pays in its domestic market.
'MOF's 10-year Yankee bond is paying an equivalent of Hibor [Hong Kong Inter-Bank Offered Rate] plus 90 basis points, while the exchange fund papers are Hibor-minus,' one banker said.
Because investors would perceive China and Hong Kong as having the same sovereign risk after 1997, they would desert the exchange fund market in search of the higher-yield paper.
Arguably, the authority would lose a crucial instrument in controlling liquidity in the money market, effectively losing its grip on interest rate levels. The ability to manoeuvre interest rates is instrumental in defending the Hong Kong dollar's peg to the US dollar.
Besides, the cost of borrowing for the exchange fund paper could go up to close the gap, making the authority's interest rate policy more costly than before.
'I think one has to take a more conservative and cautious attitude towards China issuing Hong Kong dollar debt,' the head of Asia capital markets at the Commonwealth Bank of Australia, Andrew Fung, said.
On the tax side, whether China's debt paper should be given tax exemption could be a potentially sensitive issue.
At present, profits made from exchange fund paper are fully tax-exempted.
'If China becomes a regular user of the local debt market and it is tax-exempted, then there is a potential loss in tax revenues,' one banker said. 'It would also seem that Hong Kong is subsidising China.'
