Offshore RMB Market
Renminbi ("RMB") is the legal currency of the China. It is not a freely convertible currency and is subject to foreign exchange control policies and repatriation restrictions imposed by the China government.
Since July 2005, the China government began to implement a controlled floating exchange rate system based on market supply and demand and adjusted with reference to a portfolio of currencies. The exchange rate of RMB is no longer pegged to US dollars, resulting in a more flexible RMB exchange rate system.
Over the past two decades, the China’s economy has grown rapidly at an average annual rate of more than 9% in real terms. This has enabled it to overtake Japan to become the second largest economy and trading country in the world. The International Monetary Fund projects that the China will contribute more than one-third of global growth by 2015. As the China’s economy becomes increasingly integrated with the rest of the world, it is a natural trend for the RMB to become more widely used in trade and investment activities.
Accelerating the Pace of RMB Internationalisation
The China has been taking gradual steps to increase the use of RMB outside its borders by setting up various pilot programmes in Hong Kong and neighbouring areas in recent years. For instance, banks in Hong Kong were first permitted to provide RMB deposits, exchange, remittance and credit card services to personal customers in 2004. Further relaxation occurred in 2007, when the authorities allowed China financial institutions to issue RMB bonds in Hong Kong. As at the end of August 2014, there are more than 220 banks in Hong Kong engaging in RMB business, with RMB deposits amounting to about RMB 936.80 billion, as compared to just RMB 63 billion in 2009.
The pace of RMB internationalisation has accelerated since 2009 when the China authorities permitted cross-border trade between Hong Kong/Macau and Shanghai/4 Guangdong cities, and between ASEAN and Yunnan/Guangxi, to be settled in RMB. In June 2010, the arrangement was expanded to 20 provinces/municipalities in the China and to all countries / regions overseas. In the first 8 months of 2014, nearly RMB 3,929.84 billion worth of cross-border trade was settled in Hong Kong using RMB.
Onshore versus Offshore RMB Market
Following a series of policies introduced by the China authorities, an RMB market outside the China has gradually developed and started to expand rapidly since 2009. RMB traded outside the China is often referred as “offshore RMB” with the denotation “CNH”, which distinguishes it from the “onshore RMB” or “CNY”.
Both onshore and offshore RMB are the same currency but are traded in different markets. Since the two RMB markets operate independently and the flow between them is highly restricted, onshore and offshore RMB are traded at different rates and their movements may not be in the same direction. Due to the strong demand for offshore RMB, CNH usually trades at a premium to onshore RMB, although occasional discounts are also observed. The relative strengths of onshore and offshore RMB may change significantly and such changes may occur within a very short period of time.
Notwithstanding that the offshore RMB market showed meaningful growth during the past two years, it is still at an early stage of development and is relatively sensitive to negative factors or market uncertainties. For instance, the value of offshore RMB dropped 2% against the US dollar in the last week of September 2011 amidst a heavy sell-off in the equities market. In general, the offshore RMB market is more volatile than the onshore one due to its relatively thin liquidity.
There have been discussions about potential convergence of the two RMB markets but that is believed to be driven by political decisions rather than pure economics. It is widely expected that the onshore and offshore RMB markets will remain two segregated but highly related markets for the next few years.
New measures to relax the conduct of offshore RMB business were announced in 2010. On 19 July 2010, restrictions on interbank transfers of RMB funds were lifted permission granted for companies in Hong Kong to exchange foreign currencies for RMB without limit. One month later, the China authorities announced the partial opening up of the China’s interbank bond market to foreign central banks, RMB clearing banks in Hong Kong and Macau and other foreign banks participating in the RMB offshore settlement programme.
The National Twelfth Five-Year Plan adopted in March 2011 explicitly supports the development of Hong Kong as an offshore RMB business center. In August 2011, China Vice-Premier Li Keqiang announced more new initiatives during his visit, such as allowing investments on the China equity market through the Renminbi Qualified Institutional Investor ("RQFII") scheme and the launch of an ETF with Hong Kong stocks as the underlying constituents in the China. The China government also gave approval for the first non-financial China firm to issue RMB denominated bonds in Hong Kong.
RMB Internationalisation is a Long-term Goal
Given the China’s economic size and growing influence, the RMB has the potential to become an international currency ranking alongside the US dollar and the euro. But the China has to first accelerate the development of its financial markets and gradually make the RMB fully convertible on the capital account. Although the internationalisation of the RMB will bring benefits such as increasing political influence and reduced exchange rate risks, it also entails risks including rising exchange rate volatility.
The process of RMB internationalisation is a long and gradual one. It took the US dollar many decades to replace the British pound as the dominant reserve currency. It will similarly take time for the RMB to gain importance in the coming years. The RMB will not be in a position to challenge the US dollar’s main reserve currency status for some time to come.
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