World Crisis Online

By Katrina Nicholas

March 4 (Bloomberg) — Investors are demanding the heftiest premium in almost two years to hold China’s dollar-denominated debt rather than Treasuries as rising food costs boost the potential for civil unrest.

The extra yield offered by the notes increased 17 basis points this year to 143 basis points as of March 2, according to the JPMorgan EMBIG China Sovereign Spread index. The gap reached 152 a day earlier, the most since May 2009. Russia’s premium shrank 27 to 197, while Brazil’s fell 19 to 170, comparable gauges show.

“Inflation is perceived negatively for Asia in general and China in particular,” said Pierre Faddoul, a Singapore-based credit analyst at Aberdeen Asset Management Ltd., whose Asia fixed-income portfolio of about $6 billion includes dollar debt issued by Chinese companies. “Rising food prices affect a large part of consumption, especially in rural areas, and can trigger social unrest if left untamed.”

This quarter’s growth in the world’s second-largest economy will be the slowest since September 2009, limited by interest- rate increases and borrowing curbs introduced to help contain the fastest inflation in two years, according a Bloomberg survey of economists. Premier Wen Jiabao said Feb. 27 the government will boost food supplies to hold down costs and tackle surging property prices, policies that may be outlined when the annual meeting of the legislature commences tomorrow.

Food Prices

Wen’s pledges were made as online postings called for rallies in major cities to protest corruption and misrule, inspired by uprisings in the Middle East. High food prices, unemployment and anger about corruption led to demonstrations this year that toppled Tunisia’s Zine el Abidine Ben Ali, Egypt’s Hosni Mubarak and fueled rebellion against Libya’s Muammar Qaddafi.

World food prices climbed to a record in February on a jump in dairy, grain and meat costs, according to data released yesterday by the United Nations. China’s rose 10 percent in January from a year earlier, quadruple the pace of increases for nonfood items, official figures show.

The inflation rate was 4.4 percent to 5.1 percent in the four months through January, the highest levels in two years, and the central bank raised interest rates on Feb. 9 for the third time in four months. Economic growth will slow to 9.25 percent this quarter from 9.8 percent in the three months through December, the Bloomberg survey showed.

Borrowing Costs

Rising overseas debt costs for the government may make it more expensive for China’s companies to borrow as they step up expansion beyond the nation’s borders. Chinese companies’ dollar bond sales total $8.4 billion this year, a record start to a year and up from $1.2 billion in the same period of 2010, according to data compiled by Bloomberg.

China National Offshore Oil Corp. is the nation’s biggest seller of dollar debt this year, issuing $1.5 billion of 10-year notes and $500 million of 30-year bonds in January. Its Hong Kong-listed Cnooc Ltd. unit agreed to pay $8.4 billion for energy assets in Africa, Latin America and the U.S. in the past year to boost production.

China National’s January 2021 bonds yielded 4.63 percent yesterday, 115 basis points more than similar-maturity Treasuries, based on Royal Bank of Scotland Group Plc prices. The yield gap was 100 basis points, equivalent to 1 percentage point, when the securities were sold on Jan. 21.

Default Swaps

Five-year credit-default swaps on China’s dollar bonds rose seven basis points since December to 75, CMA prices show, implying it costs $75,000 a year to insure $10 million of debt. That’s still cheaper than protection for notes issued by Japan and France, members of the Group of 10 industrialized nations.

“China is a low-debt economy and while they’ve had aggressive credit expansion it’s not like there have been years of excess,” said Sanjay Mathur, the chief Asia emerging-markets economist at RBS in Singapore. “Expectations of further price rises clearly exist, but even if policy makers do step on the brakes too hard they can turn things around quickly because of the country’s fiscal strength.”

The nation has the world’s biggest foreign-exchange reserves and its holdings increased by a record $199 billion in the fourth quarter to $2.85 trillion, official figures show.

Its debt is equivalent to 18 percent of gross domestic product, the smallest proportion of 12 Asian emerging-market economies tracked by Bloomberg. U.S. borrowings are equivalent to 59 percent of GDP, Japan’s amount to 196 percent and France’s 84 percent, according to data compiled by Bloomberg.

Growth Risk

“The fear is that authorities in China hit the brakes too hard and impede growth,” Ken Hanton, a senior credit analyst at National Australia Bank Ltd., said in Sydney. “It wouldn’t surprise me to see China’s sovereign credit-default swaps widen from here.”

The Chinese government’s $1 billion of 4.75 percent notes due October 2013 yielded 1.51 percent yesterday, seven basis points more than at the end of January, RBS prices show. The rate on its 6.8 percent bonds due in May rose to 1.21 percent from 1.17 percent.

Country Garden Holdings Co., which develops villas and townhouses in China, sold $900 million of seven-year bonds last month, making it the country’s second-biggest seller of dollar debt this year. The 11.125 percent notes due February 2018 were priced to yield 821 basis points more than Treasuries on Feb. 16 and the spread has averaged 816 points since.

Protest Calls

The yield premium on the developer’s $400 million of 10.5 percent debt due August 2015 widened 67 basis points this year to 767, while that for its $550 million of 11.25 percent notes due April 2017 increased 105 to 791, RBS prices show. Contracts insuring its debt against default have risen to 896 from 750 this year, CMA prices in New York show.

Borrowing costs may climb until investors “see signs that inflation is no longer accelerating,” said Tim Condon, head of Asian research at ING Groep NV in Singapore. “There’s skepticism that authorities are doing enough to deal with the price pressures and the Jasmine revolution worries we’re seeing highlight the urgency of this,” he added, referring to recent calls for protests in major Chinese cities.

Trader expectations for monetary tightening have been building in China’s financial markets. One-year interest-rate swaps, or the fixed cost needed to receive the floating seven- day repurchase rate, rose 60 basis points this year to 3.79 percent, according to data compiled by Bloomberg.

The yield on the government’s benchmark 10-year local currency bonds was 3.96 percent yesterday, up from 3.91 percent at the start of 2011. The rate reached 4.14 percent on Feb. 14, the highest level since September 2008. The yuan has gained 0.3 percent this year to 6.5731 per dollar in Shanghai.

–Editors: James Regan, Sandy Hendry