A year ago on 19 July 2010, the HKMA announced the permission of RMB to be transferred between accounts in Hong Kong regardless of purpose. This gave birth to the offshore deliverable RMB FX market. Many understood this to be a significant development in the process of RMB internationalization, but most were surprised by the pace of development of the offshore RMB market. The first birthday of the CNH offers a good vantage point to take stock on
these rapid developments:
- The CNH deposit base has more than sextupled in size, from a RMB90bn inert pool of currency, into a RMB549bn deposit base supporting a liquid and actively traded currency and money market.
- The FX market has gone from being non-existent to seeing over USD3bn in daily turnover in spot and forwards. It is now onpar with the previously dominant CNY NDF market, and is already one of the top offshore FX markets in Asia.
- The CNH option market has developed rapidly as well, now seeing USD200-300m daily turnover, already a significant proportion of the established offshore CNY NDF options market.
This rapid development of the underlying FX market has super-charged the internationalization process by supporting the increasing functional use of the RMB onshore, offshore, and cross-border:
- Cross-border RMB trade settlement has risen over six-fold with such trade now accounting for 7% of total trade in the first quarter, from less than 1% a year ago.
- CNH financing continues to grow, with gross issuance of CNH bonds reaching RMB138bn by mid-June, and with the first offshore RMB IPO in April announcing the birth of the CNH equity market. This growing asset base allows more opportunities for CNH deposit holders to make real investments and to enjoy real returns on their CNH exposure.
- Importantly, in the past twelve months, the government has expanded the channels of cross-border transactions to include outward and inward direct investment. This has been complemented by the opening of a narrow channel of cross-border portfolio flow: allowing certain offshore banks to reinvest CNH into the onshore interbank bond market.
And at the age of one, the offshore RMB market is still in its early infancy - we expect growth to remain exponential. Such substantial and continued growth in the coming years has
some very significant implications:
- CNH, with a demonstrated liquid and liberal market, will increasingly become a core holding of asset allocators. Already we estimate that over half of long-held long CNY NDF positions have migrated to the CNH market.
- While not yet offering the liquidity and depth characteristics sufficient to be a core reserve currency, the conventionalization of the CNH and CNH asset markets will make the RMB increasingly attractive to reserve managers as an important marginal destination of reserve diversification.
- With increasingly liberalized cross-border RMB goods, services, and direct investment transactions, the gradual opening of cross-border RMB transactions for the final class of transactions, portfolio investment, is inevitable. While this will not technically equate to liberalization of the capital account, it will in practice open China's capital markets to increasing foreign participation. As the onshore-offshore circular flow of RMB for investment becomes large enough, the issue of technical capital account liberalization will likely become irrelevant.
More immediately, what are other "first steps" do we expect from the offshore RMB market as a one-year old? We expect:
- the CNH market to fully overtake the NDF market in terms of turnover, with a similar pattern following in the options market.
- the RMB deposit base to top one trillion RMB
- the gross issuance of bonds to reach as high as RMB230bn
- the second offshore RMB market, and the first outside of Chinese sovereign soil, to be established in Singapore. This will establish the blueprint for further expansion of offshore RMB activity, most likely in other EM financial hubs first, before eventually reaching the key global financial centers of London and New York.
We are looking forward to see how the CNH will develop this year and expect the continued internationalization of the RMB to happen faster than many believe. We look forward to many more offshore RMB milestones and birthdays to come.