THE annual session of China’s parliament this week may provide a trading opportunity in its debt market: buying corporate bonds and selling government treasury bonds to capitalize on the likely effects of tax reform.

Parliament is expected to pass legislation unifying the basic corporate income tax rate for Chinese and foreign firms at about 25 percent, against 33 percent currently for local companies and 15 percent for foreign firms.

The anticipated boost to Chinese companies’ cash flow has been pushing up their shares.

The bonds, most of which are guaranteed by banks and already carry top credit ratings from local agencies, are also likely to benefit — relative to government bonds — from the reduction on taxes paid by bond investors.

Institutional investors must pay corporate income tax on capital gains from corporate bonds. But they don’t have to pay such taxes on government bonds.

So a cut in corporate tax could provide corporate bonds with some allure relative to government bonds.

“Yields on treasury bonds should rise while yields on financial and corporate bonds should fall. The spread between them will narrow,” said a trader at an Asian bank in Shanghai.

With Chinese bond yields in an uptrend for the past six weeks because of a pick up in inflation and monetary tightening, playing the government/corporate spread looks safer than buying corporate bonds outright, dealers said.

As the corporate bond market is still quite illiquid, however, investors who play the spread are likely to focus on one type of corporate bond: financial bonds issued by three policy banks — China Development Bank, Export-Import Bank of China and Agricultural Development Bank — which lend to promote government initiatives.

The spread between the indicative one-year government bond yield and the benchmark financial bond yield has narrowed about 10 basis points to 68 bps since October, when the market started talking about tax reform, Reuters reference rates show.

Analyst Ying Junhui at China Merchants Bank said the spread could narrow around 10 bps further this year.

Playing spreads for medium-term bonds such as five-year maturities may be more risky because of concern about a change in the status of policy banks longer term.(SD-Agencies)