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
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.
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
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
The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.
Foreign exchange transactions can be highly risky, and losses may occur in short periods of time if there is an adverse movement of exchange rates. Exchange rates can be highly volatile and are impacted by numerous economic, political and social factors, as well as supply and demand and governmental intervention, control and adjustments. Investments in financial instruments carry significant risk, including the possible loss of the principal amount invested. Before entering any foreign exchange transaction, you should obtain advice from your own tax, financial, legal and other advisors, and only make investment decisions on the basis of your own objectives, experience and resources.