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OUTLOOK FOR THE Renminbi

OUTLOOK FOR THE Renminbi. by Marshall Gittler Head Of Global FX Strategy. 31.1.2013. First, some terminology. The official name of the Chinese currency is the renminbi ( 人 民幣 , “People’s Currency”). Its symbol is RMB .

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OUTLOOK FOR THE Renminbi

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  1. OUTLOOK FOR THE Renminbi byMarshall Gittler Head Of Global FX Strategy 31.1.2013

  2. First, some terminology • The official name of the Chinese currency is the renminbi (人民幣, “People’s Currency”). Its symbol is RMB. • The unit of the RMB is the yuan (元 or 圓). One yuan is divided into 100 jiao(角) • Yuan is the same word as the Japanese yen and Korean won. • It means round or circle. • Its symbol is ¥ • China has capital controls, so a yuan that’s outside the country isn’t the same as one inside the country. • The official abbreviation for ones inside the country is CNY (= Chinese yuan), while the ones that are outside the country are CNH (for Hong Kong). www.IronFX.com

  3. What they are trying to do • China is trying gradually to internationalize the renminbi • 3 steps in internationalization: • China and its major trading partners transact in RMB • Widespread third-party usage of the RMB in financial and trade transactions • Central banks maintain sizable holdings of RMB as reserves • There is no historical precedent for what they are doing www.IronFX.com

  4. How they are trying to do it • China is following the same pattern with the RMB that they did with liberalising the economy • First tried out liberalising the economy in “special economic zones” • They have a two-track strategy: • RMB trade settlement • Developing offshore RMB markets • Eventually, they hope to make the RMB on par with the dollar as an international reserve currency www.IronFX.com

  5. Milestones so far • 2003: HK residents allowed to open CNH deposit • 2005: Panda bonds (RMB bonds issued in China by non-residents) • 2007: Dim sum bonds (RMB bonds issued in Hong Kong) begin • 2009: Cross-border trade settlement in CHY begins • 2009: Bilateral currency swap agreements with other CBs instituted • 2011: HK brokerage firms allowed to sell RMB-denominated ETFs that directly invest in mainland stock and bond markets • 2011: Outward foreign direct investment allowed in RMB • Countries that reportedly hold RMB bonds as part of their FX reserves include: Japan, South Korea, Malaysia, Indonesia, Nigeria, Chile and Saudi Arabia www.IronFX.com

  6. The #14 currency for payments • Went from #20 to #14 currency for payments in just one year! Source: Society for Worldwide Interbank Financial Telecommunication (SWIFT) www.IronFX.com

  7. HK markets • After explosive early growth, volumes stalled in 2012 • RMB deposits in HK have fallen, dim sum bond issuance has dropped as yields rose Source: Bloomberg Finance L.P. www.IronFX.com

  8. Has internationalisation stalled? • The globalisation of the RMB first stalled back in Oct. 2011, when the market started forecasting the depreciation of the RMB. • Globalisation based on expectations of currency appreciation is fragile. Source: Bloomberg Finance L.P. www.IronFX.com

  9. CNH expected to depreciate Source: Bloomberg Finance L.P., IronFX Financial Services www.IronFX.com

  10. Over long term as well Source: IMF World Economic Outlook www.IronFX.com

  11. China forecast to have a rising c/a surplus • If investors are no longer eager to hold RMB to benefit from expected appreciation, then it would help globalisation if the country ran a current account deficit, which would mean it is exporting money. • However, it is still running a c/a surplus and this surplus is expected to rise sharply in coming years. Source: IMF World Economic Outlook www.IronFX.com

  12. They now have both current and capital account surpluses • In fact it’s running both a current and capital account surplus, meaning little if any net RMB are flowing out of the country at all! Source: Bloomberg Finance L.P. www.IronFX.com

  13. Problems they face • In order to get more RMB out of the country, they have to liberalize the capital account so that domestic investors can shift their assets out of the country. • The drive to internationalise the RMB is really a drive to liberalise the capital account • Officials in China are likely to agree that it’s good to have a currency that matches China’s place in the world economy • People who want to liberalise the capital account can use that as a starting point that everyone agrees with and work from there www.IronFX.com

  14. Problems they face • A lot of people in China (reasonably) worry that liberalising the c/a could lead to financial instability • Volatile capital flows could lead to inflation, deflation, crises • Rich Chinese could move money abroad, drain funds from banks • Domestic IR would have to be liberalized, raising the cost of capital • Exchange rate would have to be freed as well • Banks would have to be put on a commercial footing and freed to allocate capital according to credit risk • State-owned enterprises (SOEs) lose preferential access to capital • Government would lose some levers for controlling the economy www.IronFX.com

  15. Problems they face • The main impediment to opening the financial markets is the govt’s desire to maintain direct control over the economy. • This has been their developmental model up to now, and it’s worked • The current system requires that depositors must remain captives of the domestic financial system. • If there were higher-paying alternatives to the banking system, money would flow out of the banks and the government would no longer be able to use state-controlled banks to direct investment • Hence lifting capital controls and floating the exchange rate would require the fundamental restructuring of China’s economic model www.IronFX.com

  16. Real deposit rates are negative • How long would money remain in the banks with negative real yields? • A liberalised current account would force the government to raise bank deposit rates, which would raise funding costs for companies. Source: Bloomberg Finance L.P. www.IronFX.com

  17. Problems they face • Authorities believe they can maintain domestic financial as long as they restrict the return of offshore RMB back onshore • But the success of the whole project depends on how much freedom overseas residents have to choose RMB assets • The globalisation plan depends on overseas investors wanting to increase their holdings of RMB assets. www.IronFX.com

  18. China’s capital markets are among the most closed Source: Deutsche Bank www.IronFX.com

  19. Debt markets still small • China’s debt markets are about the size of Britain’s. Not small, but not comparable to the size of China’s economy. • GBP accounts for 16% of global FX market turnover, 4% of global FX reserves. • JPY accounts for 22% of FX turnover, also 4% of reserves. Source: E. Pradad and L. Ye, “Will The Renminbi Rule?”, Finance & Development Magazine, March 2012 www.IronFX.com

  20. Financial deepening: loans vs bonds • Government bonds outstanding were much greater than bank loans even before the explosion in govt debt following the financial crisis • In China however the government bond market is much smaller than the loan market, as the government prefers to direct finance through the state-owned banking system. Source: Bloomberg Finance L.P. www.IronFX.com

  21. Chinese banks look like US banks… Source: Bloomberg Finance L.P. www.IronFX.com

  22. …but there are big differences Source: Bloomberg Finance L.P. www.IronFX.com

  23. Reserve holdings increase with financial deepening • Use of JPY in reserves has fallen as Japan’s GDP shrank relative to US • Same thing was happening with European currencies until EUR started; then financial deepening increased use of EUR • This shows the importance of deep financial markets in determining which currencies become widely held reserve currencies Source: IMF www.IronFX.com

  24. Problems they face • Lifting capital controls and floating the exchange rate would require: • facing down tough political opposition & vested interests • willingness to expose the country to new and unknown stresses and external volatilities • Implementing one of the largest set of economic and financial reforms in recent history • Even if you think all these things are worth pursuing, is now a good time to pursue them? The question facing China is not about the desirability of RMB internationalisation. It is about the nation’s priorities in reforming its financial and economic institutions. www.IronFX.com

  25. What is likely to happen? “What is needed is a roadmap with a stronger and more flexible exchange rate, more effective liquidity and monetary management, with higher quality supervision and regulation, with a more well-developed financial market, with flexible deposit and lending rates, and finally with the opening up of the capital account… If all that happens, there is no reason why the renminbi will not reach the status of a reserve currency occupying a position on par with China’s economic status.” Christine Lagarde, IMF Managing Director 18 March 2012, Beijing www.IronFX.com

  26. What is likely to happen? • Gradual liberalisation is likely to continue, but at a slow pace • Full liberalisation likely many years away, if ever • RMB likely to grow in presence, but not dominate • Could become like Japanese yen – 3% of reserves • Many years before it’s a major reserve currency • Not a threat to the dollar’s position www.IronFX.com

  27. Future liberalisation steps • Onshore companies borrowing RMB from HK and remitting the money back (already begun) • RMB-denominated commodity futures (gold, copper) to be listed in Hong Kong, London • HKEx completed takeover of LME in December • RMB settlement of USD-denominated commodity trades on the Chicago Merc, LME • Issuance of RMB-denominated stocks in Hong Kong www.IronFX.com

  28. London’s position • London is trying to position itself as a centre for offshore RMB trading • It’s crucial to achieve 24-hour CNH trading • Btu clearing CNH depends on the RMB RTGS system in HK, where several UK banks already participate • Not included in UK settlement system and not likely to be added either as it’s not convertible www.IronFX.com

  29. If you want to play… • Some brokers offer CNH on their platforms • Liquidity is a question; rates aren’t constantly updated • The IMM offers deliverable CNH futures in standard ($100k) and e-micro ($10k) size • Options will be available later • …but why play CNH when what you want is to play the Chinese economy? www.IronFX.com

  30. AUD is much more volatile Source: Bloomberg Finance L.P. www.IronFX.com

  31. Headline goes here AUD follows Chinese indicators AUD follows Chinese indicators Source: Bloomberg Finance L.P. www.IronFX.com

  32. AUD follows Chinese indicators more closely than Australian ones Source: Bloomberg Finance L.P. www.IronFX.com

  33. and more closely than CNH does And more closely than CNY does Source: Bloomberg Finance L.P. www.IronFX.com

  34. In short • RMB has been liberalised somewhat and liberalisation will continue gradually, but it will be a long time if ever before the RMB is a fully convertible and free floating • The government retains control over the FX rate within a set band. Its volatility is low and the rate does not always reflect economic conditions • RMB trade is relatively illiquid. Pricing updates are infrequent and spreads are wide • If you want to trade the Chinese economy, look at trading AUD/USD or AUD/JPY www.IronFX.com

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