24 September 2018
Progress in internationalizing the Chinese currency has been amply demonstrated -- the United States and Europe have accepted the Chinese yuan. Photo: CNSA
Progress in internationalizing the Chinese currency has been amply demonstrated -- the United States and Europe have accepted the Chinese yuan. Photo: CNSA

How a healthy offshore yuan market can come about

China’s central bank adjusted the exchange rate on Aug. 11 to close the gap between onshore renminbi (CNY) and the daily reference rate.

In doing so, however, offshore renminbi (CNH) experienced volatility and has been deviating from the daily fixing and CNY.

In fact, CNH has been undergoing change since early 2014.

It has considerably outpaced onshore renminbi.

In 2013, daily worldwide offshore renminbi trading was US$120 billion compared with US$44 billion onshore.

One year later, offshore trading volume hit US$230 billion while the onshore market rose to US$55 billion.

But since the Aug. 11 reform, onshore trading has picked up, but the offshore market has posted even faster growth.

The offshore renminbi market trades 24 hours.

And progress in internationalizing the Chinese currency has been amply demonstrated — the United States and Europe have accepted the Chinese yuan.

In the first quarter, renminbi trading in the eurozone and the US accounted for nearly half of global trading, according to SWIFT, the global provider of interbank financial communications.

We can see that renminbi trading has become more vibrant in developed markets.

And the offshore market has become more sophisticated in the European and US time zones.

Key economic data, market development and any major breaking news affect the offshore market.

It has evolved into a mix of real demand, investment and speculation from merely real demand.

Traders with real financing and hedging demand also have investment and speculation demand.

For example, some foreign banks sell hedging products to their clients and encourage them to use leverage.

During US and European trading hours, market participants have great concentration of investment demand rather than real demand for the redback.

The market witnessed a rapid pick-up in buying of US forwards and selling of yuan forwards between the second half of 2014 and first quarter, with the US dollar showing continued strength and the yuan weakening.

Volatility in emerging market currencies will also affect the Chinese yuan.

Since the second half of 2014, some emerging economies have been struggling with large capital outflow.

And some have taken yuan devaluation in August as an opportunity to weaken their currencies.

The Brazil real had lost more than 20 percent as of late September and South Africa, Russia, Malaysia and Indonesia have weakened their currencies by about 10 percent.

What factors will determine the exchange rate of the Chinese yuan in the future?

CNH posted a strong rebound last month and converged with the midpoint of the daily reference rate and CNY by the end of the month.

However, CNH weakened again in mid-October and market participants are still divided over its future outlook.

We’ve seen the motivation for a more stable or a weaker redback.

On one hand, Beijing is determined to maintain the exchange rate at a reasonable level.

The Chinese government has the capacity to stabilize the exchange rate on the back of its massive foreign exchange reserves.

On the other hand, the Chinese yuan still faces depreciation pressure given China’s slowing growth and an imminent US rate hike.

In fact, the pace of liberalization of China’s capital account and cross-border yuan flow have increased.

Hence, the behavior of the onshore and offshore markets have also changed.

More mainland Chinese institutions have established trading platforms in Hong Kong or London which enhance the impact of the onshore market on the offshore market.

It’s possible that a mutual market linkage between onshore and offshore markets such as Shanghai Hong Kong Stock Connect for equities might be introduced in the foreign exchange and derivatives market.

That will enable institutions onshore and offshore to trade in each other’s market, and that in turn, could narrow the price gap.

Separate account systems adopted in free trade zones will create opportunities for onshore financial institutions to participate in the offshore market.

Cross-border yuan flows have been widening rapidly.

Onshore agent banks have been lending more to overseas participating banks and companies are using their cross-border capital pool to pull more money outside.

Individuals are also diverting more money from the market. That could have a positive impact on the development of the offshore market.

Ying Jian, a senior economist at Bank of China (Hong Kong), contributed to this article which appeared in the Hong Kong Economic Journal on Oct. 23.

Translation by Julie Zhu

[Chinese version中文版]

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General manager, development planning department, BOC (Hong Kong)

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