UPDATE 1-Hong Kong eyes bond issues to deepen debt market

HONG KONG, Feb 25 - Hong Kong plans to issue more government bonds to further stimulate the financial hub's debt market, its financial secretary said on Wednesday during his annual budget address.

"In view of the current investment market conditions and low interest rates, we believe that there is demand for quality bonds," said John Tsang, Hong Kong's financial secretary.

The Hong Kong government last issued bonds in 2004 when it raised HK$20 billion from institutional and retail investors. The debt comprised U.S. dollar- and Hong Kong dollar-denominated bonds of various tenors.

Analysts expect the issuance proposed in the budget to replace some of the bonds issued in 2004 which are maturing during the year.

They also expect the government to issue 5-year bonds because of the flatness of the yield curve beyond that maturity.

Tsang said the sums raised will be credited to a fund to be established under local public finance legislation. The fund will not be treated as part of the fiscal reserves and will be managed separately.

While Tsang gave few specifics of the fund or the size of issuance, he said approval would be sought from the city's legislature as soon as possible.

Tsang suggested the initiative stemmed from a desire to promote the bond market, rather than as a result of structural fiscal difficulties, requiring the raising of public funds through bond sales.

"Promoting the development of the bond market is important to reinforcing Hong Kong's position as an international financial centre."

However, the local bond market is dominated by trading in government-backed exchange fund notes (EFN) issued by the Hong Kong Monetary Authority and analysts do not expect the proposed bonds to displace EFNs as the market benchmark.

"It will be difficult to take away the benchmark status from the EFN market," said Frances Cheung, fixed income strategist with Standard Chartered Bank.

"I don't see the government bonds competing with exchange notes as the market benchmark," she said referring to the poor liquidity of the government bonds.

She said the rationale for the bond issuance lay elsewhere.

"The impact in promoting the bond market will be quite insignificant. If it is for supporting government spending and future investment it is a good reason."

Hong Kong's finances have been showing increasing strain from the financial crisis after a healthy surplus last year.

Tsang said the city's consolidated deficit this year is expected to hit HK$39.9 billion ($5.2 billion), or 2.4 percent of gross domestic product.

He added that he didn't expect a budget surplus to emerge till the 2012/13 financial year. The city's economy, which fell into recession in the third quarter last year, is forecast to contract by 2-3 percent in 2009. ($1=7.753 Hong Kong Dollar)