HONG KONG: The government will kick off a HK$100 billion ($12.9 billion) sovereign bond program as early as September, selling first to institutional investors via an auction, sources close to the deal said on Friday.

"The market expects the yields of the government bond to fall somewhere between the Exchange Fund notes and IRS curve, but likely closer to the IRS curve as it (sovereign bonds) will not be eligible for repo transactions," said one source.

Two-year Exchange Fund notes, issued by Hong Kong's central bank and usable for repo transactions, yielded about 0.37 percent on Thursday and 2-year interest rate swaps yielded about 1.3 percent.

Earlier this year, the government announced plans to sell up to HK$100 billion in bonds in the coming 5 to 10 years to increase the breadth, depth and liquidity of the city's debt market. Money raised will be placed with the Exchange Fund for investment.

The issue size will depend on market demand and the government said initial market overviews indicate that investors are willing to buy HK$10 billion to HK$20 billion in government bonds over the course of a year.

"The bonds will be divided into two tranches, institutional and retail, and the institutional portion will launch first, as there is strong demand in the market," a source said.

A schedule for the bond auction will be announced "very soon" and the auction will probably take place four weeks after that, he added.

The Hong Kong Monetary Authority will coordinate the issuance of the bonds and manage the fund. The timing for the retail portion will depend on market conditions, including investor interest, allowing that current interest rates may be too low to attract enough retail investors.

"Retail investors tend to be more sensitive to prevailing market conditions and absolute yield level," he said.

Preparation for the retail portion is already well under way, the source said. The government is relying on professional advice from co-arrangers about suitable market conditions for the offer, the source noted.

The coupon of the retail bond would be correlated with the yields of the institutional tranche, he added.

The government of Hong Kong has an AA-plus rating from Standard & Poor's, the agency's second highest, with a "stable" outlook.

The authority also said yesterday the assets of the Exchange Fund, which is used to back the Hong Kong dollar, totaled HK$1,833.2 billion ($235.0 billion) at the end of June.

The figure was HK$73.1 billion higher than the total at the end of May, with foreign currency assets and Hong Kong dollar assets rising HK$52.3 billion and HK$20.8 billion respectively, the city's de facto central bank said in a statement.

The rise in foreign currency assets was due mainly to an increase in securities purchased but settled in the following month and purchases of foreign currencies with Hong Kong dollars.

Reuters

(HK Edition 08/01/2009 page2)