Chinese Yields Invert as Bond Shortage Outweighs Inflation

For the first time since 2008 Chinese companies are paying less to borrow for 15 years than for five, reflecting a shortage of longer-dated debt and confidence policy makers will curb inflation.

The average yield on yuan corporate debt maturing after 2025 was 4.67 percent in December, compared with 4.97 percent for three to five-year bonds, according to Bank of America Merrill Lynch’s China credit indexes. The last time the gap was wider was on Aug. 13, 2008, when the spread reached 31 basis points, or 0.31 percentage point.

The shift in borrowing costs makes it more attractive for companies to sell the longest-term bonds as the quickest pace of inflation in 28 months fails to damp demand for debt in the world’s fastest-growing major economy. In the U.S., average yields for corporate bonds maturing in three to five years were 3.15 percent last month, and bonds maturing in 15 years or more yielded 5.87 percent.

“There isn’t much supply of long-term paper in the corporate bond market, which is still very much in its infancy,” said Donald Straszheim, head of China research at International Strategy & Investment Group in Los Angeles. “If you believe that China is not going to allow inflation to get out of control, then long-dated paper makes a lot of sense.”

Bank of America’s China index of three- to five-year corporate bonds tracks 70 securities. The benchmark for bonds maturing in 15 years and more comprises 12 securities, sold by borrowers such as China Ministry of Railways, the biggest issuer of corporate bonds in 2010, and China Datang Corp., the nation’s second-largest power producer. The equivalent 15-year plus benchmark for U.S. companies tracks 1,056 bonds.

Inflation Curbs

Policy makers twice raised interest rates last year and increased the proportion of deposits that lenders must set aside as reserves six times as part of wider measures to curb inflation and asset bubbles. Consumer prices rose 5.1 percent in November from a year earlier, driven by food, according to a statistics bureau report Dec. 11.

“As the view develops inflation is not going to get out of hand, that will also tend to bring short-rates down,” Straszheim said. “You’ll see the curve move back to a more normal slope.”

China National Petroleum Corp.’s 15 billion yuan （$2.3 billion） of 3.9 percent notes due in June 2017 yielded 4.59 percent yesterday, according to Chinabond prices. The country’s biggest energy producer’s 3.97 percent five-year notes yielded 4.615 percent, the data show.

Shaanxi Coal

Shaanxi Coal and Chemical Industry Group Ltd.’s 1 billion yuan of 4.15 percent bonds due May 2021 yielded 5.085 percent yesterday, Chinabond prices show. The company’s 1.5 billion yuan of 5.45 percent bonds due December 2017 yielded 5.396 percent, the data show.

Spending on railways, power plants, highways and other large-scale infrastructure projects is accelerating as people flock to cities from rural areas. China will have an urban population of about 1 billion people by 2025, and may spend 11.1 trillion yuan over the next 10 years on electricity plants alone, according to McKinsey Global Institute and China Electricity Council forecasts.

“Most bonds being sold are in the three to five-year range, not in the 10-year-plus zone,” Jeremy Amias, co-founder of fixed-income brokerage and advisory firm, Amias Berman & Co., said from Hong Kong. There hasn’t been the same shift in borrowing costs affecting government bonds because of the “relative lack of supply” of corporate debt with longer maturities, he said.

Bank of Beijing

Bank of Beijing Co. sold 6.5 billion yuan of 15-year bonds at a 5 percent coupon on Dec. 23, according to data compiled by Bloomberg. Five Chinese companies sold yuan-denominated bonds with tenors of 15 years or more in 2010, compared with three in 2009, the data show.

The yield on China’s 2.68 percent government bond due in November 2013 fell 4 basis points to 3.34 percent on Jan. 5, Chinabond prices show. The yield on India’s three-year bonds declined 4 basis points to 7.89 percent yesterday. Similar maturity bonds yield 7.1 percent in Russia and 12.3 percent in Brazil.

Five-year credit-default swap contracts on China’s bonds were little changed at 69 basis points yesterday, CMA prices in London show. The contracts fell 8 basis points last month. Credit-default swaps typically decline as investor confidence improves and rise as it deteriorates.

The yuan fell for a third day, declining 0.11 percent to 6.6265 per dollar yesterday in Shanghai according to the China Foreign Exchange Trade System. Non-deliverable forwards show traders are betting on a 2.7 percent increase in a year.

Interest-Rate Swaps

One-year interest-rate swaps, or the fixed cost needed to receive the floating seven-day repurchase rate, rose 4 basis points to 3.165 percent yesterday. Five-year swaps gained 8 to 3.91 percent, according to data compiled by Bloomberg.

Chinese local-currency bonds returned the least last year among the so-called BRIC nations, The 1.8 percent gain was lower than the 13.1 percent advance in Brazil, 10.4 percent increase in Russia and 6.2 percent rise in India, JPMorgan Chase & Co. indexes show.

In Europe, where Greece and Ireland have received financial bailouts to help recover from the financial crisis, the average yield on three to five-year company bonds last month was 3.71 percent, less than the 4.8 percent for debt with tenors of 10 years and more, Bank of America indexes show.

China’s long-dated corporate bond market will take time to grow, according to Zhang Zhiming, the head of China research at HSBC Holdings Plc.

“The difference between companies in China versus the West is that in the West, you have a lot of companies with scale, and mature capital markets,” he said in a phone interview from Hong Kong. “Here, only top names can tap that space.”