Offshore renminbi (CNH) will decouple from its onshore counterpart (CNY) while Beijing keeps a closed capital account, ING Group’s chief economist, Tim Condon, told an audience in Singapore this week, effectively creating a new currency in Hong Kong.
Speaking during a panel discussion at the RMB Rising conference, jointly hosted by AsianInvestor and FinanceAsia following a similar successful event in Hong Kong, Condon notes that “the huge difference between yields of onshore and offshore RMB [bonds] is a testimony of capital account restriction in China”.
Currently, offshore RMB bonds are trading at much lower yields compared with their onshore peers. For instance, the five-year Chinese government bond is trading at around 1.7% in the offshore market, while in the onshore interbank market the five-year government bond is yielding 3.6%.
As China creates more channels for RMB to flow out to the rest of the world, but continues to restrict the inflow of RMB back to the mainland, “you will see the decoupling of CNH from onshore CNY”, Condon states.
He points out that the convergence of the two RMB exchange rates largely depends on capital account liberalisation efforts by Beijing.
Noting that this process is primarily driven by political decisions, he expects the CNY and CNH to remain “two different and not integrated markets for the next couple of years” because of Beijing’s desire to maintain financial and economic stability.
Since offshore RMB trading began in July last year, the CNH has usually traded at a premium versus CNY, with the spread peaking at around 2.6% in mid-October. But as CNH-denominated bond issuance faded in late December and market conditions thinned, CNH has temporarily traded at a 0.3% discount to CNY.
Robert Minikin, senior FX strategist at Standard Chartered, recently stated that the outlook for CNH premium is “a matter of political economy rather than just economics”.
“The pace at which importers are allowed to transfer funds from the onshore to the offshore market, and the pace at which CNY is created in Hong Kong ahead of remittance to the mainland, are both closely controlled by mainland authorities,” he wrote in a report.
Condon similarly notes that the divergence between CNH and CNY is subject to authorities in Beijing and Hong Kong, who moderate the pace of RMB liberalisation in the manner of “two steps forward and one step back”.
To dampen speculative arbitrage transactions on the CNH and CNY spread, last December the Hong Kong Monetary Authority (HKMA) suggested that “particular attention be paid [by banks] to transactions in large amounts requested by new customers, or transactions between entities that are related to each other”.
To ensure better management of foreign exchange risk, the HKMA also instructed banks to restrict their RMB net-open positions (whether long or short) to 10% of their assets or liabilities in the currency, whichever is larger.
The authorities’ control over RMB liberalisation and the rapid rise of an offshore RMB pool are creating conditions for the CNH to become a new currency, in Hong Kong in particular.
The supply of RMB in Hong Kong has been rising sharply, supported by individuals accumulating RMB deposits and foreign exporters retaining RMB proceeds in Hong Kong rather than selling them to the clearing bank (BOC HK) at onshore rates, which tend to be discounted, or converting them offshore.
The growing appetite for RMB in Hong Kong indicates that “people are seeing RMB as store of value instead of just betting on its appreciation potential, as a large part of the RMB deposits in Hong Kong are time deposit”, Adrian Foster, Rabobank International’s head of financial markets research for Asia-Pacific, notes at the conference.
According to the latest statistics from the HKMA, RMB deposits increased to a total of Rmb280 billion ($42 billion) at the end of November last year from just Rmb60 billion at the end of 2009 – a 367% increase.
By contrast, the overall foreign currency account in Hong Kong increased by just 15% in the past year, notes Foster.