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Updated: 2007-06-28 11:20

The national legislature yesterday debated a draft bill authorizing the Ministry of Finance (MOF) to sell 1.55 trillion yuan (US$200 billion) of special treasury bonds to finance the proposed foreign exchange investment company.

The funds raised will be used to buy US$200 billion of the country's total of US$1.2 trillion foreign exchange reserves from the central bank, and invested overseas.

The bill, submitted by the State Council to the National People's Congress Standing Committee, is expected to be approved.

The government decided earlier this year to establish a sovereign wealth management fund to dilute its whopping foreign exchange reserves.

Minister of Finance Jin Renqing yesterday told lawmakers that the issue - the country's biggest - will help "reduce the size of China's forex reserves" and "improve the returns on forex assets".

According to official figures, by the end of March, forex reserves had reached US$1.202 trillion, up US$135.7 billion from the end of 2006.

Explaining the massive scale of the issue, Jin said China's forex reserves were likely to continue to rise, and the central bank will face more pressure in coping with excessive liquidity even after recent measures to reduce currency in circulation.

The bonds will help domestic enterprises do business abroad and enhance national economic competitiveness, Jin said.

Details of the issue, such as whether the bonds will be issued directly to the central bank or sold in the domestic market, are not available.

Analysts agree the US$200 billion bonds would be long-term and issued in tranches with the interest rate expected to be in line with market levels.

"The news is obviously encouraging for the international market," said Chen Xingdong, chief economist of BNP Paribas Peregrine Securities. "The money may be used (overseas) to buy blue-chip companies or for mergers and acquisitions."

For the domestic market, however, it could have a negative impact, he told China Daily.

"Although within market expectations, it is still bad news as it will divert a huge amount of money from the domestic market."

Analysts said the central bank and the Ministry of Finance must coordinate carefully to avoid adverse effects on the money market.

"The central bank would have to work closely with MOF on this, otherwise money market rates could go haywire," said Stephen Green, chief economist with Standard Chartered Bank (China). "We expect the central bank to draw back on its own bill issuance program... allowing the authorities to issue the special bonds."

The State foreign exchange company, still in an embryonic stage, has already spent US$3 billion for a 10 percent stake in Blackstone, a US private equity group.

This is seen as a sign of change from the previous strategy of investing most of the foreign exchange reserves in safe US treasuries.

Since the market situation is changing, it is normal for China to invest some of its reserves in riskier but more profitable portfolios, said Zhao Xijun, finance professor at Renmin University of China.