Foreign exchange: Offshore renminbi celebrates first anniversary

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By:
Hamish Risk
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Growth exceeds expectations; Chinese authorities slowly loosen capital controls

size of deposit base of the offshore deliverable renminbi currency market

 size of deposit base of the offshore deliverable renminbi currency market

Just over a year ago, the Hong Kong Monetary Authority granted permission for quantities of Chinese renminbi to be transferred between accounts in Hong Kong for any purpose for the first time. This marked the birth of the offshore deliverable renminbi (CNH) currency market.

The market’s growth has exceeded most people’s expectations. The CNH deposit base has reached Rmb549 billion ($85 billion) and the offshore renminbi currency market has gone from being practically non-existent to a $3 billion-a-day trade in spot and forwards. The offshore renminbi is now on a par with the previously dominant renminbi non-deliverable forward market (NDF), and has quickly formed one of Asia’s top offshore FX markets. In May CNH trading volumes in Asia surpassed the average daily trading volumes in the NDF market, and HSBC, one of the largest CNH market-makers, expects that the new currency will soon surpass NDF trading in Europe as well. The CNH currency options market has quickly developed too: average daily volumes are about $200 million to $300 million, HSBC adds.

Key drivers

Such rapid growth has been facilitated by two key drivers: a six-fold increase in renminbi trade settlement, which accounted for 7% of total mainland China trade in the first quarter of 2011, up from 1% a year ago, and a revival of the Hong Kong-based CNH bond market, whose first issuance was back in 2007 but has been reawakened by the insatiable appetite of offshore depositors to buy real assets. Issuance jumped 300% in the second quarter of 2011 as a mixture of Chinese onshore borrowers and international issuers took advantage of the cheap funding rates of less than 2%.

Thus, the internationalization of China’s currency, putting it on the path towards becoming the next reserve currency, has been set in train, or perhaps more accurately, has set off on ‘training wheels’ towards full convertibility. However, there still remain limits on the amount of capital that is allowed to flow between the onshore and offshore markets. Indeed, the People’s Bank of China has in the past slapped the wrists of banks in Hong Kong to remind them that they’re not completely free to transact FX business with corporate clients for trade accounts, and that deals must be approved on a case-by-case basis. Ditto for foreign direct investment, such as Chinese borrowers raising renminbi in Hong Kong.

Internationalization: a core policy

And should the flow of hot money become too great, might the Chinese authorities bring down the shutters? After all, China’s inflation is running at a three-year high and cheap funding from Hong Kong might only fuel that further. No, say analysts – the internationalization process is unlikely to go into reverse.

"It’s clear that this is core policy, it’s very important and cannot be ignored," says Daniel Hui, a senior foreign exchange strategist at HSBC in Hong Kong. Hui adds that the situation is akin to what happened in Europe 20 years ago, when the Maastricht Treaty was signed, setting the wheels in motion for the establishment of the euro.

The Chinese authorities are in effect letting renminbi liquidity expand out of China by creating the offshore platform in Hong Kong and then gradually letting the two pools interact more. By opening up a very small channel for portfolio flow investment, they’ve allowed a certain number of banks and financial institutions to take existing renminbi raised in the CNH market and reinvest it in the onshore interbank bond market. In June the Bank of China, one of the most active issuers in the CNH bond market, received approval to bring CNH10.5 billion back onshore and invest it in the local treasury bond market. This was a rare thing for the authorities to do, being only the second approval given after China Merchants Bank won similar permission.

Continued growth

So what does that all mean for the continued growth of the trading volumes in the CNH currency market?

"The CNH is a huge success and one can freely buy it, sell it, borrow it and lend it," says Mark Johnson, global head of FX cash trading at HSBC in London. "This is a growing market which is constantly evolving, although at present there aren’t enough instruments to satisfy the demand, which limits the amount of investor involvement. To aid further growth a larger bond market would enable investors to place CNH in instruments other than short term deposits"

Future growth very much depends on how tightly the People’s Bank of China controls investment portfolio flows from offshore to onshore. As long as investors believe that owning renminbi is a one-way bet, and while deposit rates in Hong Kong might be almost negligible at less than 1%, the real gains are in the appreciation of the currency.

That might also deter overseas borrowers from coming to the CNH bond market, because although it might be cheaper, they’re taking the wrong side of the currency exposure, because in all likelihood the currency will have appreciated by the time the bond matures. 

Also see

Voracious investors grow picky amid CNH supply glut
June 2011

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