* Portugal plans to sell government bonds in China
* Would be first euro zone state to issue in renminbi
* Deal could strengthen cultural, economic links
* Other European countries keeping close eye on progress
By John Geddie and Dhara Ranasinghe
LONDON, July 3 (Reuters) - Portugal is looking to build on its economic and cultural ties with China by becoming the first euro zone country to borrow in the $9.5 trillion Chinese bond market, potentially opening the way for other European governments.
Beijing is tentatively removing barriers to foreign issuers as it seeks to internationalise its renminbi or yuan currency and open up sources of finance for its planned “One Belt, One Road” trade route that stretches as far as Europe.
Portugal, whose location on Europe’s Atlantic coast is some 10,000 km (6,250 miles) from Beijing, further away than any of its euro zone peers, plans to sell “Panda” bonds -- debt sold by foreign entities to investors in mainland China.
“In practical terms, the issue aims to diversify the sources of financing of Portugal, opening a new market for its debt, and support the internationalisation of the (renminbi),” a spokesman for the office of Prime Minister Antonio Costa told Reuters.
He said strengthening trade links between the two countries would benefit both populations.
Just a handful of foreign entities -- including sovereigns Poland and South Korea -- have sold Panda bonds in recent years, although Hong Kong’s smaller, offshore, yuan-denominated “dim sum” market is well established.
Panda bond issuance increased ninefold last year to 130 billion yuan ($19 billion), and is expected to grow by another 50 percent in 2017, according to JPMorgan.
Portugal’s ties with China date back some 500 years to the settlement of Macau, the trading post-turned-gambling hub that was Europe’s last colony in Asia until it was handed back to China in 1999, just as Portugal joined the euro.
After a crippling recession that pushed the indebted country into a bailout in 2011, Chinese cash helped aid its recovery.
Portugal is currently the top destination for Chinese investment in Europe as a share of its economy, according to figures from Spain’s ESADE Business & Law School, and a number of Chinese firms have taken stakes in Portuguese companies.
China Three Gorges owns 21 percent of Energias de Portugal while private conglomerate Fosun upped its stake in bank Millennium bcp to 24 percent in February.
Last year, Costa told Chinese state television that Portugal wanted to “actively participate” in Beijing’s plans to develop a maritime sea route as part of the trade route initiative, dubbed the new Silk Road. He highlighted port capacity at Sines in Portugal’s south.
Hong Kong-based Richard Mazzochi of law firm KWM, who has been involved in a number of Panda bond deals, said linking to a specific project could help get Portugal’s planned debt sale off the ground.
“Applications are easier to make where there is already an established connection and if an issuer would use the proceeds in connection with One Belt, One Road initiatives, that would be helpful,” he said.
A deal could raise eyebrows among European authorities suspicious of China’s plans to spread its global influence and concerned about transparency and access for foreign firms to the scheme. Major European countries have even mooted the idea of blocking Chinese investment on the continent.
The EU is assessing whether a Beijing-funded rail project in Hungary, which has issued debt in China’s offshore market and is eyeing the onshore market, complies with EU law.
Finance Minister Mario Centeno told Reuters in May that selling a bond in the Chinese currency would allow Portugal to take advantage of growing demand for its debt, especially as a strengthening economy raises hopes for a credit rating upgrade.
The planned end in December of the European Central Bank’s bond-buying scheme means diversifying into China -- the world’s third-biggest debt market, behind the United States and Japan -- might appeal to other euro zone states.
Contacted by Reuters, the debt offices of Ireland, Italy and Belgium said they were open to issuing in yuan, while France, Spain and the Netherlands said they had no such plans.
A German government source said such a transaction “had been on the table one or two years ago” but for “cost reasons” Berlin decided against it.
Bankers at Standard Chartered and HSBC told Reuters they were working with European sovereigns on deals, but gave no details.
Although China is nervous about capital outflows, a foreign government issuing there would serve as an endorsement of plans to internationalise the currency and its standing as a global economic power.
Mushtaq Kapasi, chief representative, Asia-Pacific at the International Capital Market Association, said Portugal’s sovereign would also “give Chinese investors a level of trust”.
In October, the yuan was added to the International Monetary Fund’s small basket of reserve currencies, while the ECB added the Chinese currency to its foreign reserves this year.
Spencer Maclean, a banker at Standard Chartered, said a sovereign bond sale would be a “precursor” for private firms from the country to tap Chinese markets.
But barriers to entry remain.
Bankers told Reuters that some countries may be nervous about the legal framework under which the bonds would be sold. As Greece and Argentina experienced during their debt crises, it is hard to restructure bonds issued under foreign law.
The most common concern expressed by issuers is whether they will be able to get the cash they have borrowed out of China.
“The Chinese allow capital to flow in but it is still quite a challenging situation to convince the Chinese to use the proceeds abroad,” said Alexander Liebethal, head of new issues at German development bank KfW, which has issued in the Chinese offshore market.
“If you look at the Panda market you will see a lot of issuers active there that have operations in China, like some German car manufacturers.”
New guidelines on Panda bonds expected from Chinese regulators should add some clarity, bankers and lawyers said.
And for all that Portugal’s deal is innovative, it may not be imminent.
“These sort of projects take time,” said Portugal’s debt agency chief Cristina Casalinho. “It would be a novelty for us.”
Additional reporting by Sergio Goncalves in Lisbon; Graphics by Gustavo Cabrera; Editing by Catherine Evans