Goldman Says China's Bond Market to Gain in Influence (Update1)

Goldman Says China's Bond Market to Gain in Influence (Update1)
Nhung, 0986263204 SG
By Christina Soon
Nov. 22 (Bloomberg) -- China's bond market will gain in influence in the next 10 years as the economy grows and the government deregulates the market, Goldman Sachs Group Inc. said.
Outstanding debt may reach 60 percent of the economy in 2016 from about 27 percent now, as the yuan and interest rates are allowed to fluctuate more freely, according to a Nov. 20 Goldman report. An aging, increasingly affluent population will spur demand for bonds, said Francesco Garzarelli, director of macro and markets research in London.
Higher per-capita incomes ``usually translate into greater sophistication or maturation of capital markets,'' Garzarelli said in an interview yesterday.
China wants to encourage companies to borrow through debt issuance instead of taking loans from banks, which have been saddled with $163 billion of non-performing debt. An expanding bond market will help sustain economic growth, by putting a more accurate price on investment risks, Goldman said.
The government's decision this month to let banks lend bonds for the first time shows determination to develop the market, Garzarelli said.
Banks can lend their bonds for a period of one year starting Nov. 20, the People's Bank of China, the central bank, said on Nov. 6. The rules allow for short positions, where an investor borrows an asset in anticipation of making a profit by buying it back after its price has fallen.
Growing Economy
China's seven-year government bonds fell today. The yield on the 2.51 percent local-currency bond due in February 2013 rose 1 basis point, or 0.01 percentage point, to 2.99 percent at 2:30 p.m. in Shanghai, according to the Shanghai Stock Exchange.
Should the market reach 60 percent of the economy's estimated size in 10 years, it would be worth the equivalent of $4.5 trillion, the current size of the U.S. Treasury market, Goldman's report said.
The economy of China, the world's most populous country, expanded 10.4 percent in the third quarter after growing 11.3 percent in the previous three months. Growth in the second quarter was the fastest in more than a decade.
``The sound situation of the Chinese economy since the mid- 1990s, with high growth and low inflation'' was contributed by factors including the increase in employment as a percentage of total population, Li Yang, a former member of the PBOC's monetary policy committee, said today in Beijing.
``Because those factors will continue for another 10 years, the Chinese economy will continue to be in such a sound position for a long period of time,'' Li said at the Chinese Academy of Social Sciences' Institute of Finance & Banking, which he heads.
Goldman Sachs based its estimation on the assumption of average annual GDP per capita growth of around 6 percent, the report showed.
Pricing Risks
To promote market growth, borrowing costs should be more flexible so investors can price risks, Garzarelli said. The central bank lifted its one-year lending rate twice this year to 6.12 percent to cool the world's fastest-growing major economy. While the lending rate sets a minimum borrowing cost for bank loans, it doesn't directly influence money-market rates.
The yield on a 2 billion yuan ($254 million) sale of one- year central bank bills was 2.82 percent yesterday, compared with 2.79 percent at sales in the past seven weeks.
Since the end of a fixed exchange rate in July 2005, China's central bank has limited gains in the currency to 2.9 percent by purchasing dollars and keeping yuan money market rates stable.
Exchange Rate
``China's current exchange rate regime constrains the use of market-oriented instruments -- interest rates chief among them -- in the conduct of monetary policy,'' Garzarelli co-wrote in the report with economist Sandra Lawson and strategist Michael Vaknin. `This has the unfortunate side-effect of curtailing the pace of local debt market development.''
China's national household savings rate at 24 percent of disposable income is more than three times the Organization for Economic Cooperation and Development's average, the report showed. The country has one of the highest rates of bank deposits to GDP in the world, it said.
``A more robust debt capital market could facilitate the conduct of monetary policy and underpin the sustainability of the long-running economic boom,'' the report said. It could also ``channel funds into institutional investments and reduce the need for precautionary household and corporate savings.''