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In the News

Azerbaijan Buys Australian Government Bonds

Wall Street Journal

November 26, 2012

Written by ENDA CURRAN

SYDNEY—Azerbaijan, the Caspian nation best known for its caviar and petroleum, is buying Australian government bonds, joining a growing list of sovereign investors acquiring debt Down Under in a trend that has seen the Aussie dollar labeled a potential safe-haven currency by the International Monetary Fund.

The former Soviet republic's $33 billion dollar sovereign wealth fund—the State Oil Fund of the Republic of Azerbaijan, or Sofaz—said it quietly started buying Australian bonds in July at a time when market data show the Aussie dollar gained 3.4% in value over the month.

"The main purpose of these investments made within Sofaz's investment policy is diversification of its currency basket," the fund said in written responses to questions from The Wall Street Journal. "Additionally, Sofaz is expecting these investments to enhance its return in the light of extremely low-yield environment in U.S. and European financial markets."

Sovereign investors such as Azerbaijan buying Australian dollar-denominated debt and assets are blamed by analysts and the central bank for helping to inflate the value of the currency at a time when interest-rate cuts and softer commodity prices were expected to bring the Aussie below parity with the U.S. dollar. Sofaz joins investors said to include Russia and the Swiss National Bank SNBN.EB -1.93% that have bought into the resource-rich country this year. Foreign ownership of Australian bonds has grown to a record 76%, more than double the levels seen a decade earlier, as central banks and others pile into the nation's debt securities, official figures show.

Because of offshore interest, the International Monetary Fund has said it's considering awarding the Aussie dollar safe-haven status by including the measure in its official currency reserves report, the Composition of Foreign Exchange Reserves, or Cofer. The report gauges the currency stocks of central banks around the world helping to set a benchmark for safe assets. The overwhelming proportion of these reserves are held in U.S. dollars, euros, pounds sterling, Japanese yen and Swiss francs.

Australia keeps only partial data on which individual countries hold its sovereign debt, and the increase in foreign investors has led to calls for a more comprehensive register. Figures released by the Australian Office of Financial Management show Asian countries are the biggest buyers of Australian bonds, followed by European states and North America.

The appeal of Australian sovereign bonds has broadened dramatically since the credit crunch in 2008. One of a dwindling number of sovereigns rated triple-A by the three major ratings firms, Australia has little debt and an economy that has survived a slowdown in demand for industrial commodities such as iron ore and coal. The government expects net debt to peak at around 10% of national output, and unemployment remains at a manageable level below 5.5%.

Yields on Australia's bonds are relatively high compared with developed peers, even after the central bank aggressively eased monetary policy. The Reserve Bank of Australia, or RBA, has cut rates by 1.50 percentage points to 3.25% since last November to partly ease the strength of the dollar. Such is the RBA's concern about the high exchange rate—partly caused by foreign demand for Australian bonds—that it recently started a policy of allowing its foreign currency reserves to grow in a passive form of intervention.

But these measures have so far had little effect on either the Aussie dollar or bond yields. For example, three-year government bonds issued by Canberra yield around 2.75%, compared with around 0.3% offered on two-year U.S. Treasury notes, and the Aussie dollar is up year-to-date against its U.S. counterpart.

Pacific Investment Management Co, one of the world's biggest bond managers, known as Pimco, is among investors other than central banks also favoring Australian debt securities in the current environment.

"The Australian bond market is likely to remain attractive to offshore investors, due to the clean sovereign balance sheet and the higher real yields compared to other major bond markets," said Robert Mead, managing director and head of Asia-Pacific credit portfolio management at Pimco.

So far, Sofaz said that around 200 million Australian dollars (US$209 million) has been allocated into shorter-dated Australian government bill notes and bonds. Its overall mandate allows up to 5% of its investment portfolio to be held in countries with a credit rating in the single-A category or higher.

The wealth fund was set up in 1999 to capture revenues flowing from the Caspian nation's vast oil and gas fields. In the first nine months of this year, oil output fell 7.9% compared with the same period the year before, to 32.75 million metric tons, according to the State Oil Company of Azerbaijan Republic, or Socar.

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