* Offshore investors own 83.5 pct of Aussie federal bonds
* With govt debt supply thin, state debt becomes attractive
* State debt offers extra 115-150 bps yield; highly rated
By Cecile Lefort
SYDNEY, Aug 6 As yield-hungry investors from Colombia to Kazakhstan lap up Australia's rare and safe government bonds, it seems only a matter of time before they acquire a taste for the country's A$200 billion ($211.1 billion) highly-rated regional debt markets and help ease state borrowing costs.
Desperate to diversify their currency reserves, central banks and sovereign funds from far afield have been piling into Australian commonwealth government bonds, one of the few liquid triple-A sovereign debts left.
"You name a country and they have it," said a fixed income banker who asked not to be named because he's not authorised to speak to the media.
Offshore holdings of the A$238 billion Australian sovereign bonds on issue have ballooned to around 83.5 percent, up from 71 percent a year ago and around a third a decade ago, Barclays research data show.
Colombia, Peru, Brazil, Kazakhstan, Bangladesh, Israel and Russia are among the more unusual names cited by three Asia-based bankers with direct knowledge.
With Australian 10-year bond yields hovering around record lows near 3 percent, they still offer an attractive alternative to those in most developing countries. Germany and the Netherlands are even paying negative yields on very short-term paper.
To the envy of most nations, Australia has little public debt and, with the Labor government pledging to return to budget surplus by 2013, Australian sovereign bonds will become even more scarce.
Analysts expect government debt on issue to remain around the current A$230 billion mark, which is less than half what the U.S. Treasury sells every month.
With a shrinking pool of debt and a growing hunt for yield, analysts anticipate foreign investors will migrate to other types of top-rated Australian dollar assets previously overlooked, such as bonds issued by state governments.
"It's only a matter of time before official reserve managers have a look at them," said Stephen Miller, head of fixed income at BlackRock Australia, a unit of BlackRock Inc, the world's largest money manager.
China's central bank, the world's largest holder of reserves, is reportedly exploring investing in such securities.
Also called semi-governments, the states of New South Wales, Victoria and Western Australia are rated triple A and have a total of around A$95 billion of bonds on issue, according to the UBS Composite Benchmark.
So far, demand for their debt has lagged behind their federal counterpart and these securities have been offering premiums as high as 115 basis points over government bonds since 2007/08.
The gap is even wider for states rated AA-plus, such as resource-rich Queensland, with dealers quoting 150 basis points above Australian sovereign bonds.
Such a wide difference is one of the reasons BlackRock Australia, which manages around A$42 billion in total assets, has bumped up its allocation of state bonds.
And it may increase it again.
"It's one of the things we have been very focused on for much of 2012," said Miller, seeing yields as extremely attractive.
One hurdle, though, is a perceived lack of liquidity in the semi market as around half of all state debt is held by Australian banks to satisfy Basel III liquidity reserve requirements, which makes them very reluctant to sell.
"The semis market doesn't have the depth of U.S. Treasuries," said Charlie Jamieson, co-head of fixed income at Bank of America Merrill Lynch in Sydney, referring to the state government bond market. "But it is a fully functioning market and you can buy them at a price should you wish to invest."