CHINA CURRENCY: Code red

07/10/2010 | Elliot Wilson

China is moving fast to create an offshore renminbi currency market. The redback finally seems willing to take on the greenback

China’s renminbi – also known as the yuan or the redback – has long been an inflexible currency, its purpose largely to keep the country’s exports competitive. But moves are afoot to make the renminbi a more flexible way of settling cross-border trade, with the ultimate aim of creating a fully floating, unpegged currency.

After years of prevarication, on August 16, China opened the doors of its domestic interbank bond market to the central banks of a select group of nations including Argentina, Belarus, Indonesia, Iceland and South Korea. Analysts at Standard Chartered called the move a “very important piece of the puzzle for the development of a significant offshore renminbi market in Hong Kong”.

On September 8, Bank of China began issuing up to Rmb5 billion of bonds in Hong Kong with maturities of two and three years to retail and institutional investors. Five days later, Euroclear Bank said it would allow clients to settle transactions and deposit Eurobonds and Hong Kong securities denominated in renminbi from September 27.

Then on September 19, Beijing publicly allowed Malaysia’s central bank to buy yuan-denominated bonds, taking the credibility of the renminbi as an international currency to a new level. Other Asian central banks are also believed, quietly, to have bought yuan-denominated Chinese bonds in recent months.

Even foreign-listed corporates have got in on the act. McDonald’s has recently issued yuan-denominated bonds, as has HSBC’s mainland China operations and Hong Kong-listed Hopewell Highway Infrastructure.

The key questions now are these: how big can the offshore renminbi market become; and who will benefit. The answer to the first question is, simply put, “enormous”.

Philip Lynch, chief executive officer Asia ex-Japan at Nomura, says: “Given the importance of Chinese trade flows and the increasing liberalization of the RMB, the offshore renminbi market will over time be as important as the Eurobond market.”

In July 2009 HSBC chief China economist Qu Hongbin predicted $2 trillion of annual cross-border trade (around half the mainland’s total) could be settled in the yuan by 2012. That would make the renminbi one of the top three currencies in global trade.

Standard Chartered says that comparisons between the offshore-renminbi (CNH) and Eurodollar markets are inevitable: “We expect significant CNH liquidity growth as a result of renminbi trade settlement, tourist receipts and other renminbi flows.” The bank reckons that CNH bond issuance could grow faster, were the rules surrounding the ability to transfer funds into the mainland further relaxed.

SLIM PICKINGS

Trade in the CNH has so far been relatively thin. At around $4 billion, the offshore-renminbi market is just 0.1% of the onshore total of around $2.9 trillion. Daily offshore spot foreign exchange transactions in the renminbi are meanwhile around $30–50 million, or 0.2%, of the $20 billion onshore spot market. Moreover, CNH deposits, in the Hong Kong banking system, make less than one-tenth of one percentage point of China’s $10 trillion onshore renminbi deposit base.

Yet this isn’t stopping cities and states in and around China from seeking to establish their own credentials as offshore centres. Hong Kong is the logical base for a CNH market, though its mainland twin, Shenzhen, is also trying to muscle in on the act. The Qianhai region of the city plans to develop an onshore-offshore financial centre working hand-in-hand with Hong Kong – though it remains unclear what purpose this would fulfil.

The next step with the renminbi should be the creation of the so-called “mini-QFII”– a variation on the qualified foreign institutional investor scheme. This is likely to be introduced later this year or early next.

The project, originally designed as the ‘through-train’ scheme, announced and then scrapped in spring 2009, should allow Hong Kong residents to convert Hong Kong dollars into renminbi by acquiring Shanghai and Shenzhen-listed ‘A’ shares.

“That would provide Hong Kong residents with an incentive to actually hold renminbi,” says Lucy Feng, regional head of bank research, Asia ex-Japan at Nomura. “We expect more investment opportunities in the renminbi to appear after that, such as investing in the mainland fixed income and interbank markets.”

For now, China seems content to roll out a series of bold pilot projects big enough to boost interest in the CNH market. Beijing’s new currency-related assertiveness also has a knock-on benefit: as other countries buy Chinese bonds as reserve assets, upward pressure on the renminbi is created – helping, if only partially, to mollify US politicians keen to label China a currency manipulator.

Andy Rothman, chief China strategist at CLSA, believes that once Beijing becomes more comfortable with global growth prospects, appreciation in the renminbi versus the US dollar will return to the 5–7% annual pace of the 2005–08 period. Following China’s September surprise, the redback finally seems willing to take on the greenback.

In time, don’t bet against it winning.

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