The Offshore RMB (CNH) One Year After

A year ago this month, the RMB cross border trade settlement scheme was expanded to 20 Mainland Chinese provinces and cities. Mainland Designated Enterprise (MDE) exporters in these provinces were allowed to settle trade transactions in RMB with any part of the world, while Chinese importers had no restrictions in paying RMB to overseas vendor. The subsequent Clearing Amendment removed obstacles that prevent offshore RMB bonds and the money market from developing in Hong Kong. Since then, offshore banks can offer a wide range of RMB services without restrictions, including bank loans, deposits and FX services, as long as funds do not flow back to the Mainland without approval from the relevant Mainland authorities.

How quickly has the offshore CNH market grown? 

The steady stream of liberalization measures introduced by the Chinese authorities and the Hong Kong Monetary Authority has driven rapid growth in the offshore market, most evident in the ballooning of RMB deposits in HK. CNH deposits increased fourfold to CNH315 billion outstanding at year end 2010 and continued to grow to CNH510 billion at the end of May, making up more than 8 percent of total deposits in Hong Kong.

Source: PBOC, as of 6/1/11  

The CNH money market rates are currently very low compared to those available for onshore. The lack of investment outlet means most excess CNH funds with offshore banks end up being placed with the clearing bank, Bank of China (BOC) HK. China's central bank pays 0.72 percent to BOC, which in turn pays about 0.63 percent to banks in Hong Kong for their RMB deposit.

Source: Datastream, People's Bank of China
Reuters graphic/Christine Chan 

The CNH deposit growth has been driven by an increase in RMB receipts through the Pilot Cross Border RMB Trade Settlement scheme. China trade settled in RMB grew from around RMB50 billion in Q2 2010 to RMB350 billion in Q1 2011. The regulation is a lot more facilitative to Chinese importers than exporters, since only the approved MDEs (67k+ names) can receive CNH for their exports, whereas any Chinese importers can pay RMB. That explains the steady growth of offshore CNH liquidity.

So far, trade related flows have been mainly from Asian companies, while activities from U.S. and European companies have been slower to pick up. This is probably due to the fact that U.S. and European companies have all along settled trade in their domestic currencies. On the other hand, Asian companies who have already settled in a third currency (USD) are more willing to settle in the CNH.

Some companies that settle trades in USD habitually are reluctant to set up the infrastructure to facilitate payment in CNH (e.g. open CNH accounts, set up invoices/payments in CNH, etc.), and do the necessary research to ensure the Mainland beneficiary is MDE approved to receive payment in CNH. Once these companies change their behavior, RMB trade settlement will have room to expand.

The FX market has also experienced spectacular growth. The turnover in the offshore RMB (CNH) FX market reached US$ one billion per day in May, with around $800 million in spot transactions, with the remaining $200 million in forwards and swaps. With the RMB up 5.2 percent over the past 12 months, it has become easier for offshore companies to hedge their FX risk with CNH-denominated instruments such as deliverable forwards and options. Previously, this was only possible via non-deliverable forwards, which do not involve exchange of RMB outside China.

Future potential 

The Chinese authorities appear to have used the RMB appreciation to help fight imported inflation driven by firm global commodity prices, but at the same time kept a tight grip on the appreciation pace to cushion capital inflows. This trend is likely to continue for the rest of the year, with the PBOC expected to use its daily fixing to guide the RMB to more peaks but with intermediate pauses. Apart from its internal needs, China is also under external pressure to let its currency appreciate to help balance its surplus-ridden trade with other major economies.

In addition, we think the RMB cross border trade settlement pilot scheme is gaining a lot of traction. Chinese importers need to buy US$1.6 trillion worth of goods in 2011. Since the scheme is more accommodative of importers' payments, their decisions on payment will have a huge impact on FX flows. Given that import invoicing in RMB has picked up substantially, onshore companies no longer have to buy USD in the open market. As such, the usual demand for USD against RMB will be diminished.

Based on the above factors, this trend will continue and we predict USD/CNH spot rate to be around 6.2500 by year end 2011 and 6.2000 by Q1 2012.

Last week, the offshore CNH forward curve has steepened because of a Wall Street Journal story last week indicating that BOC HK had received the approval to repatriate roughly USD1.6 B from a Dim Sum bond issuance. This caused market panic, taking this as a sign that China was liberalizing its capital account enabling BOC to borrow cheap CNH at 70 bps offshore and invest those proceeds in Mainland China in higher yield investments. The expected CNH borrowing will increase CNH yields and hence upward pressure on the USD/CNH forward curve.

Suddenly, CNH forwards went from being priced off appreciation expectations to pricing off of interest rates. This is an important development. From the rate table below, the current CNH and NDF 12-month forwards are only pricing at 0.7 percent and 1.3 percent appreciation respectively. This is much lower than the actual appreciation of close to 2 percent (4.8 percent annualized) since the beginning of 2011 and the 2 percent forward discount a few weeks ago. For those who need to hedge RMB appreciation in the coming months, current spot and forward rates are good levels to sell USD and buy CNH.

Source: Bloomberg, as of 6/1/11