Chinese mainland state-owned banks that lend to government projects are selling the most yuan-denominated debt ever in Hong Kong before the nation's finance ministry floods the market with a record offering of Dim Sum bonds.

The Agricultural Development Bank of China, a policy bank under the People's Bank of China, is marketing three maturities of the securities, as total sales by policy banks rise beyond 15.8 billion yuan (US$2.5 billion) for the year, at yields that are about 10 basis points less than what they pay for three-year debt in Chinese mainland. The borrowing advantage is set to diminish as the ministry readies its own offshore sale.

The government plans to offer 23 billion yuan of the bonds this month, as Hong Kong marks 15 years since it returned to Chinese sovereignty and the country expands use of its currency for trade and international funding. The regulator in the world's second-biggest economy eased access to the Dim Sum market last month, after Chinese Vice Premier Li Keqiang opened the door for direct sales by the country's companies and commercial banks last year.

"The Ministry of Finance is planning such a large issuance that it could create some potential market indigestion," said Becky Liu, a strategist in Asian credit research at HSBC Holdings Plc. "The sales are part of the government effort to establish a liquid benchmark for the offshore market to further development."

Hard sell

Borrowers have sold less than double the amount of Dim Sum bonds that the Chinese government is planning for its sale, with total issuance of 38 billion yuan this year, according to data compiled by Bloomberg News. Yields surged 19 basis points in the two days following the government's last sale in August, the biggest two-day rise in more than three months, according to Bank of America Merrill Lynch indexes.

"The offshore yuan market remains a cheaper source of funding compared with the onshore capital market although the difference is now shrinking," said Chia Tse Chern, who manages UOB Asset Management's United Renminbi Bond fund and co-heads fixed income from Singapore. "Yields may go up if the Ministry of Finance issues a large amount."

Offshore deposits in the currency fell in April for a fifth-straight month to the lowest level in almost a year, according to the Hong Kong Monetary Authority, reducing the amount of money that can be invested in yuan products. Appreciation expectations for the yuan have waned to 2.1 percent for 2012, down from 2.9 percent at the beginning of the year, according to estimates of more than 25 analysts. Dim Sum bond yields have risen 57 basis points during the last three months, Bank of America Merrill Lynch indexes show.

"It's been very tough for smaller corporates to sell Dim Sum bonds," said Frances Cheung, a senior strategist for Asia at Credit Agricole SA. "They realize they need to pay quite high yields so maybe that has slowed issuance a bit. I would expect to see either policy banks or corporates that are linked to the government dominating the market again."

The Export-Import Bank of China raised 2 billion yuan this week with two notes, including a five-year bond that paid 3.35 percent, about 20 basis points less than the cost of debt onshore, according to data compiled by Bloomberg News. The policy bank came to the Dim Sum bond market even as the premium it must pay to borrow in the mainland over government securities fell to a three-month low of 63 basis points.

The lender wants to diversify its funding as well as encourage the Dim Sum bond market and promote the internationalization of the yuan, it said in an e-mailed statement on Tuesday. It sold a 15-year note alongside the five-year debt, becoming only the second issuer to sell that maturity after China Development Bank Corp earlier this year.

Elsewhere in China's credit markets, the yield on 10-year Chinese government bonds added 1 basis points to 3.4 percent in Shanghai as of Thursday.

Five-year credit-default swaps insuring China's sovereign debt against non-payment fell for a fourth day on Thursday, the longest stretch since March 19, according to data provider CMA.

The contracts fell 2.2 basis points to 121 basis points, the lowest level in more than a month, as of Thursday in Shanghai, according to CMA, which is owned by the CME Group Inc and compiles prices quoted by dealers in the privately negotiated market.

The swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to debt agreements.

Frequent issuers

The yuan was little changed on Thursday even as the central bank strengthened its reference rate by the most in a week.

The People's Bank of China raised the daily fixing by 0.13 percent, the most since June 7, to 6.3191 per dollar on Thursday. The yuan traded at 6.3703 per dollar in Shanghai, compared with 6.3691 on Wednesday, according to the China Foreign Exchange Trade System.

China's policy banks have issued this year more than triple the Dim Sum debt sold in the same period last year, according to Bloomberg News' compiled data. The Eximbank has used all of its 6 billion-yuan issuance quota for the year, according its Tuesday statement. The China Development Bank has raised 6.8 billion yuan in 2012.

The Agricultural Development Bank of China is marketing a sale of two-, three- and five-year Dim Sum bonds, according to a person familiar with the matter on Thursday, who asked not to be identified because the details are private. The two-year notes are being offered to investors to yield 2.98 percent, while the three-year portion will pay 3.2 percent, the person said. The five-year debt is being offered at a yield of 3.35 percent, the person said.

"The sales are part of the government effort to establish a liquid benchmark for the offshore market to further development," said HSBC's Liu. "There needs to be more regular issuance by top tier names to encourage that and we expect policy banks will look to come to the market more frequently."