The record-high spread between offshore yuan and onshore yuan has attracted a lot of attention in recent weeks.
At present, the market size of offshore renminbi deposits and the dim sum bond market is about 100 billion yuan (US$15.2 billion) each while daily nominal transactions of offshore yuan are about US$10 billion.
The offshore market plays a key role in renminbi internationalization and is an indispensable supplement to the onshore yuan market.
The offshore US dollar market is the world’s largest and most liquid.
The greenback became the dominant force in global trade settlement and as a reserve currency after the collapse of the Bretton Woods System.
Since then, the well-developed offshore market has cemented the dominance of the US dollar.
Chinese policymakers consider renminbi internationalization a long-term strategy.
Beijing has set its macroeconomic policy to help achieve that goal and developing the offshore yuan market is a key step in that direction.
China needs to build a multi-tier capital market which can satisfy the requirements of trade settlement, investment, multi-party financing onshore and offshore.
However, there is usually a huge divergence in internal and external legal structures, regulations and macro policy.
The onshore market can’t satisfy the demand for more diversified and convenient transaction tools by market participants.
The regulatory difference between the internal and external economic and political environments is usually an incentive for creating an offshore market.
And a more relaxed regulatory framework is to the development of the offshore market.
For example, global producers and investors used a market-driven offshore dollar market to circumvent controls over interest rates and exchange rate in the US in the 1960s and 1970s.
By contrast, the offshore renminbi market is grappling with a shrinking base, high prices and restricted cross-border flow.
The offshore renminbi market fell in 2015 and massive amounts of the currency has reentered the onshore market.
Renminbi deposits in Hong Kong posted sharp decline at one point last year.
New issuances of dim sum bonds have almost stopped. Offshore yuan lending has contracted.
These developments in the offshore renminbi market are reminiscent of the US dollar market in the 1960s.
Then, the greenback was under huge depreciation pressure as a result of a deteriorating balance of payments and shrinking gold reserves.
The US economy was struggling at that time.
The US government took various measures to intervene in the offshore market but it turned out that technical intervention only worked temporarily.
They did nothing to improve market fundamentals.
Although the offshore market is relatively freer than the onshore market, the former is deeply impacted by the latter.
The status quo in offshore renminbi market is rooted in the onshore market. The Chinese central bank is trying to maintain a balance between a stable currency and internal targets such as economic growth and employment.
This reflects a continuing struggle for the world’s major central banks after World War II.
Meanwhile, China has no structural trade deficit to which it can export renminbi to the offshore market.
There is very limited cross-border direct investment and equity investment.
Central bank intervention will only put more pressure on the offshore market.
Beijing might put a lid on the offshore renminbi market in the short term.
On the other hand, the offshore market will continue to have vast growth potential as long as Chinese policymakers remain serious about making the renminbi a world reserve currency.
This article was contributed by Zhang Haitao, a director of the Chinese Financial Association of Hong Kong, and was published in the Hong Kong Economic Journal on Jan. 13.
Translation by Julie Zhu
[Chinese version 中文版]
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