• USD-RMB rebounds after registering 2017 lows.
• China removed regulatory hurdles to help alleviate excessive RMB strength.
• Expectations for the 19th National People’s Congress.
It has been a bumpy ride for the RMB this year. After posting a high of 6.8597 on June 27th, USDCNH fell nearly -6 percent to 6.4435 on September 8th. Part of the move was due to broad USD weakness as policy reforms in the U.S. stalled and some safe haven flows rotated into the RMB with rising tension in the Korean peninsula. Despite the USD Index losing -6.6 percent over the same period, RMB strength was still evident as it outperformed against the FX basket with the effective exchange rate gaining 3.5 percent.
The rapid appreciation of the Yuan became discomforting to Chinese authorities and on September 8th, the People’s Bank of China (PBOC) removed capital controls that were introduced in Oct 2015 to contain capital outflows. Together with US tax reforms gaining some traction in recent weeks and geopolitical risks fading, USDCNH recovered 1.7 percent from the September 8th lows to the current rate of 6.5500.
China removed regulatory hurdles
The People’s Bank of China announced two key measures on September 8th:
1) Removing the 20% USD reserve requirement for onshore short CNY FX forward positions.
2) Adjusting the reserve requirement for offshore bank’s RMB deposits with onshore banks.
Removing CNY FX forward reserve requirement
In an effort to slow the RMB’s advance, the PBOC lowered the reserve requirement denominated in USD for short CNY / long foreign currency FX forward outright positions from 20 percent to zero percent for financial institutions executing on behalf of clients. Previously, the reserves were held in a zero interest account with a lock up period of one year.
Previously, the required reserves were applied to FX forwards (20%) and options (10%), while FX swaps were exempt. To avoid reserve charges, many foreign investors preferred to hedge using swaps instead of outrights. However, the inflexibility of this instrument probably resulted in less hedging activities. When investors fund their onshore investment, they would have to decide upfront whether they need to hedge the exit and in what amounts. However, in many cases the timing of the exit and amounts may be less certain.
With the reserve cost of hedging CNY removed, arbitrage opportunities are likely to increase and this could help drive convergence between the onshore and offshore markets. The offshore CNH forward curve is currently trading above the onshore from one month out, with the difference in the one year tenor at around 420 pips. Given this new dynamic, it is more cost effective to hedge through the onshore forward market across all tenors from one month onwards.
Adjusting offshore bank’s RMB deposit reserve requirement
The PBOC also changed the rules regarding reserve requirements for offshore banks placing RMB deposits with onshore banks. Onshore agent banks and RMB clearing banks no longer needs to keep a separate account to hold reserve payments for offshore bank deposits in the mainland. Previously, these funds were locked up for three months with the position adjusted on a quarterly basis, but now they are treated as normal onshore customer deposits and the required reserves positions are adjusted every 10 days.
Prior to this fine-tuning, offshore banks were incentivized to increase lending at each quarter end to reduce their overall CNH liquidity position and avoid having large sums of cash being locked up in required reserves. Despite these new changes, the total amount of reserves paid to the PBOC should remain unchanged, hence liquidity should also be unaffected. The key benefits are that offshore banks will now have more flexibility to shifts reserves between onshore and offshore markets when liquidity conditions change.
19th National People’s Congress
The National People’s Congress takes place every five years to induct a new line of Chinese leaders. There should be little surprises as the ruling party is expected to consolidate political power, which could assist in the government’s effort to more efficiently roll out financial reforms. Removing the reserve requirements was just an early steps in the process to gradually free up capital controls.
Source: Reuters, Bloomberg
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