China: Investors lose appetite for dim sum

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By:
Lawrence White
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CNH volatility as currency expectations fade; China hits back with CNH-boosting policies

Chinese vice-premier Li Keqiang

Chinese vice-premier Li Keqiang said that the government would implement measures to support the CNH market

This year could be an important test for the development of China’s offshore renminbi-denominated debt markets, as keen investors become sceptical about the inevitability of the currency’s appreciation and amount of liquidity in dim sum.

The Hong Kong-issued, renminbi-denominated bonds, also known as CNH, as opposed to CNY (onshore) paper, enjoyed a honeymoon start to 2011, with deals selling out as investors in the territory put their idle renminbi holdings to work.

Then in September and October, the CNH market became volatile, with HSBC research attributing the sharp divergence from relatively stable onshore debt to factors including the ease with which global investors can exit CNH trades relative to onshore investments, the lack of diversity in the CNH investor base and the lack of a central bank in the dollar-CNH trade that could smooth liquidity.

HSBC estimated that before the September volatility period, liquidity in the CNH market "reached $1.5 billion per day in spot and $3 billion in forwards in Hong Kong". That liquidity then decreased markedly in line with global volumes, but the bank claimed in its report – Offshore RMB Q&A: the top-10 questions investors are asking – that volumes should recover as sentiment improves.

Now the CNH market faces a more uncertain outlook than it did this time last year. Investors in the bonds were happy to accept low yields because they factored in what they saw as the inevitable appreciation of the currency. Expectations for the Chinese currency are now more mixed, and debt bankers selling CNH deals have a harder time marketing them to investors as a safe bet on renminbi appreciation.

Adding to the bearish outlook for the market, there are signs that other parts of China’s plans to internationalize the currency are not working as well as hoped. Data from the People’s Bank of China showed that the volume of cross-border renminbi trade settlement, one of the cornerstones of the internationalization project, fell in the third quarter of 2011 for the first time since the project began in 2009.

total liquidity in spot and forwards in CNH in Hong Kong

total liquidity in spot and forwards in CNH in Hong Kong

Michael Pettis, professor of finance at Guanghua School of Management, Peking University – and long sceptical of the inexorability of the renminbi’s rise – said this is because the redenomination of trade into the currency was driven more by speculative demand on its appreciation than genuine demand.

China, of course, is determined that its currency will become an international standard, and investors in the CNH market might be cheered by some progress here. On December 7, Baosteel became the first mainland Chinese company to issue renminbi bonds directly in Hong Kong – rather than via a subsidiary – with a Rmb3.6 billion ($570.8 million) deal led by Deutsche Bank and HSBC.

The move followed an announcement by Chinese vice-premier Li Keqiang in August that the government would implement measures to support the CNH market, including mainland companies being able to issue directly and a promise that the government would issue more benchmark notes to help set prices.

This year, then, will see the bullish one-way attitudes of the expectant CNH investor base – in the market since its creation in July 2010 – replaced with a more balanced view, in which the renminbi’s appreciation is not seen as inevitable and CNH deals are not automatically oversubscribed as a result.

In its report, HSBC highlighted this "greater recognition of two-way risk in USD-CNH", continued growth of the deposit base in Hong Kong, regulatory tinkering, the development of an offshore renminbi lending market and promotion of new settlement centres, such as Singapore and possibly London, as likely developments for this year. The currency is freely tradable offshore, the bank stated, and these new hubs would act as aides rather than competitors to Hong Kong.