economics briefing 05 - dbs bank...rise of the renminbi dbs asian insights economics briefing 05 02...

DBS Group Research • June 2014DBS Asian Insights05n

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economics BRieFinG

Asian Gamechangers

Rise of the Renminbi

DBS Asian Insights ECONOMICS BRIEFING 0502

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Executive Summary

Evolution of Offshore Yuan

Building More Clearing Lines

Signing More Currency Swaps

Expanding Repatriation Channels

Enhancing Yuan Exchange Rate Flexibility

Gaining Momentum

Establishing Free Trade Zones

Speeding Up Capital Account Convertibility

International Yuan Usage – Taking the Pulse

March Quarter DRIVE Reading Falls

Yuan Appreciation, Policy Support and Corporate Usage

Navigating the Way Forward

Notes

Executive Summary decade ago, China’s currency had almost no status as an international unit of exchange. As the currency of a nation strategically but cautiously opening itself to the global economy, the yuan remained highly illiquid and inaccessible in an international context. This fact was anomalous with the generally accepted

prognosis that China would very likely be the world’s largest economy within the next few decades. China’s first reforms to internationalise its currency in 2004 were indeed modest but intentional and measured steps taken since then have enabled the currency’s irreversibly greater engagement with the global financial system.

A suite of reforms undertaken since 2010 has helped accelerate the reform process and hastened the currency’s internationalisation, most notably through Hong Kong as a hub for the yuan’s offshore use. Critical next steps in this process include the opening up of the nation’s capital account and the liberalisation of its interest rates market. Initiatives such as the Shanghai Free Trade Zone show a clear intention by China’s regulators to take the nation’s currency and financial markets further in this direction.

The other critical requirement for the successful internationalisation of the yuan is sufficient offshore usage and liquidity. In this regard, the past four years have seen the currency make visible progress from previous emerging market obscurity to becoming one of the top ten most-used units for global payments. Importantly for regulators, appreciation expectations for the currency are mostly driven by corporate requirements, not the outlook for China’s economy.

DBS Group Research • June 2014DBS Asian Insights05n

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ECONOMICS BRIEFING

Asian Gamechangers



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Asian Gamechangers


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Nathan [email protected]

Produced by:Asian Insights Office • DBS Group [email protected]

Evolution of Offshore Yuanince establishing an offshore yuan market in 2004 with the launch of personal yuan banking in Hong Kong, China has taken increasingly rapid steps toward internationalising its currency. China’s 12th five-year plan unveiled in November 2013 states clearly that Beijing is in full support of Hong Kong’s development as an

offshore yuan centre, highlighting its prominence in the process of yuan internationalisation.

In 2010, Hong Kong was declared the first offshore yuan centre, creating a deliverable, offshore form of the currency for the first time. This propelled the growth of offshore development in Hong Kong effectively; evident by a nine-fold jump in yuan deposits during 2010-2011. With 945 billion yuan worth of resident deposits as of March, deposits account for 12% of Hong Kong banks’ total deposit base.

Being an important entrepot of the mainland, Hong Kong has been handling most of the yuan trades. In March, Hong Kong accounted for 90% of China’s total yuan cross-border trade settlement, compared with an average of 83% in 2013.


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With the rapidly expanding liquidity, Hong Kong has also become a centre for the issuance of offshore yuan bonds, known colloquially as dim sum bonds. Total outstanding dim sum bonds (including certificates of deposit) reached 692 billion yuan by the end of March. A wide range of domestic and multinational corporations, banks, and sovereigns have tapped the market.

The launch of the interbank market in October 2010 provided a huge boost to trading volumes of foreign exchange (FX) spot and forward market. Currently, the estimated daily FX market turnover in Hong Kong is nearly US$20 billion in the spot and forwards markets. The introduction of the FX options market, which followed gradually, led to the innovation of structured products. Meanwhile, banks in Hong Kong also offer a wide range of yuan-denominated financial products both at the corporate and retail levels.


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Type Sub-type

Certificates of deposit

Bonds Financial institutions incorporated in Mainland ChinaNon-financial institutions incorporated in Mainland ChinaCorporates incorporated outside Mainland ChinaSupranational, Sovereign and Agency

Structured deposits / notes

Insurance products

Investment funds RMB fundsRQFII funds

Equity products Real estate investment fundsDual currency listed stocks

Exchange-traded funds RMB Gold ETFsRQFII A-share ETF

Derivative Currency futures

Others RMB FDI: Equity injection / foreign debt / shareholder’s loan

Jan 2013 Hong Kong Monetary Authority shortens yuan liquidity facility to T+1 from T+2. Yuan futures can be used to offset Hong Kong banks’ offshore yuan (CNH) net open position in opposite directions

Feb 2013 Taiwan’s domestic banking units begin yuan business. First offshore yuan bond in Taiwan is issued. China begins cross-border loan scheme in Qianhai

Mar 2013 China Securities Regulatory Commission (CSRC) changes the RQFII scheme to include insurance companies and to allow investment in stock-index futures, initial public offerings, convertible bond sales and share placements in addition to equities and bonds

Apr 2013 People’s Bank of China (PBOC) signs agreements with Monetary Authority of Singapore and ICBC Singapore to establish a yuan clearing facility in Singapore

May 2013 PBOC releases new RQFII account guidelines increasing RQFII to 270 billion from 70 billion. Clearing bank begins clearing CNH trades in Singapore

Jun 2013 CNH HIBOR fixing, the first official CNH interest rate benchmark, is officially launched in Hong Kong. PBOC and Bank of England (BOE) establish a 200 billion swap line

Jul 2013 PBOC announces a series of measures to simplify yuan cross-border transactions

Sep 2013 China launches its first free trade zone in Shanghai

Oct 2013 China extends RQFII programme to Singapore and the UK. PBOC signs bilateral yuan swap agreement with the European Central Bank amounting to 350 billion yuan

Mar 2014 PBOC widens the US dollar to Chinese yuan trading band from 1% to 2% around the central parity

Mar 2014 BOE signs an agreement with PBOC to enable the clearing and settlement of yuan transactions in London

Mar 2014 China and Germany sign a memorandum of understanding on establishing a yuan clearing and settlement mechanism in Frankfurt

Mar 2014 China grants French financial institutions a RQFII quota of 80 billion yuan

Apr 2014 Hong Kong Futures Exchange starts the after-hours trading of its RMB Currency Futures

Apr 2014 Hong Kong Exchanges and Clearing plans to begin trading yuan-denominated copper, aluminium and zinc mini-futures contracts this year

Apr 2014 CSRC and Securities and Futures Commission approve in principle the development of the Shanghai-Hong Kong Stock Connect

Offshore yuan investment products / repatriation channels

Major regulatory changes announced in 2013 and 2014

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With the success in Hong Kong’s yuan story, Beijing in 2013 turned to other areas to promote wider use of its currency. The most significant development would possibly be the creation of additional offshore yuan clearing arrangements.

Building More Clearing Lines

In the first half of 2013, yuan clearing arrangements were established in Singapore and Taiwan, similar to the clearing system in Hong Kong. Within a short period, Singapore witnessed encouraging developments in both its institutional and retail yuan businesses.

Greater transparency in the movement of yuan funds has been seen in the city-state. Companies that have benefited include large multinational commodities companies with invoicing and treasury centres in Singapore. These firms thus hedge and optimise their receipt and payment of offshore yuan. Chinese companies with procurement offices set up in Singapore to purchase raw materials from Southeast Asia also benefited as they mainly trade with China and settle in offshore yuan.

As a gateway to Southeast Asia, Singapore provides a platform for Beijing to facilitate wider use of the yuan in China-Asean trade. In the longer term, as the yuan’s regional influence continues to grow, the yuan clearing line will be utilised by not just Singapore but its trade partners too. This is a great opportunity for Beijing to promote the “third party” usage of the yuan (trades not involving China), a major attribute of any international currency.

Equally impressive, the build-up of yuan liquidity pool in Taiwan is strong given its substantial cross-strait trade. As of March, yuan deposits in Taiwanese banks totalled 268.4 billion yuan.

The clearing line allows Taiwan’s manufacturers to invoice and settle their mainland trades directly in yuan, rather than swapping from yuan to US dollar first before final conversion to the Taiwan dollar. Taiwan’s manufacturers benefit from less exchange rates risk associated with US dollar volatility. They also benefit from lower transaction costs. Moreover, Taiwanese enterprises operating in China are now able to repatriate their yuan funds back to Taiwan officially.


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Hong Kong Singapore Taiwan

Yuan deposits 945 billion yuan 200 million yuan 268 billion yuan

Clearing bank Bank of China (Hong Kong)

ICBC Singapore branch Bank of China Taipei branch

Personal daily conversion limit

20, 000 yuan; @ onshore yuan rate

No limit; @ offshore yuan rate

20, 000 yuan; @ onshore yuan rate

PBOC swap 400 billion yuan 300 billion yuan N.A.

Summary of offshore yuan centres7

Singapore

Taiwan

Singapore provides a platform for Beijing to facilitate wider use of the yuan in China-Asean trade

In March, Britain and Germany signed agreements with China to enable the clearing and settlement of yuan transactions, marking the first time there will be yuan clearing banks in G7 countries. This development should attract more European enterprises to switch to the yuan in trade settlement and help yuan funds accumulate in Europe.

Hitherto, Europe relies on Hong Kong’s infrastructure (the Real Time Gross Settlement system) to clear yuan trade. According to the Hong Kong Monetary Authority, the cross-border settlement between Hong Kong and the mainland accounted for about 10% of the daily yuan settlement; with 90% being “purely offshore”. That implies most of transactions are occurring either between Hong Kong and overseas markets or among overseas markets via Hong Kong. Such strong offshore demand bodes well for the growth of yuan business globally after more clearing platforms are set up.

Signing More Currency Swaps

Aside from creating clearing lines, the People’s Bank of China (PBOC) has recently further established a number of currency swap agreements with overseas central banks; particularly the Bank of England and the European Central Bank. Since 2008, the PBOC has signed a total sum of 2.5 trillion yuan swap lines with 23 foreign central banks.

Swap lines, on one hand, act as a backdrop in the event of market stress. On the other hand, it provides additional liquidity for foreign banks to facilitate yuan trade financing activities. They also support Beijing’s reserves diversification objective by swapping the yuan into foreign currencies, which could then be invested in foreign sovereign bonds. The outstanding swap lines last accounted for merely 10% of China’s US$3.95 trillion foreign reserves. This suggests plenty of scope for further expansion.


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Europe

China’s deal with the UK and Germany marks the first time there will be yuan clearing banks in G7 countries

Expanding Repatriation Channels

To accelerate the global use of the yuan as a currency of choice, the Chinese government has been very active in broadening yuan repatriation channels. In 2013, Beijing extended the Renminbi Qualified Foreign Institutional Investor (RQFII) scheme to Singapore and the United Kingdom, with quotas of 50 billion yuan and 80 billion yuan, respectively. The quota for Hong Kong was also quadrupled to 270 billion yuan. In March, China granted French financial institutions a RQFII quota of 80 billion yuan.

The RQFII allows offshore investors to invest directly in the onshore financial markets, which would raise the attractiveness of yuan to offshore investors. Meanwhile, as Beijing seeks to continue liberalising its financial system, it is crucial to provide international investors more avenues to participate in the onshore market.

Currently, the aggregate value of RQFII quota totals 480 billion yuan, representing less than 1% of the total market capitalisation in China. The PBOC governor had earlier indicated that the quotas for RQFII will be further increased and scrapped eventually.

Enhancing Yuan Exchange Rate Flexibility

China is also promoting its currency to offshore investors at the same time it is reforming the yuan foreign exchange system. To increase the flexibility of the yuan exchange rate, the PBOC widened the trading band for US dollar-yuan in March to 2% around central parity from 1% previously. Corporates have proceeded to take on various hedging strategies to mitigate the accompanying increase in exchange rate volatility. More small and medium enterprises are expected to invoice in yuan because they lack the experience and/or expertise to hedge foreign exchange risks effectively.


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By adopting the yuan, foreign companies can also enjoy the price discounts offered by some mainland companies. The mainland authority estimated earlier that overseas importers paying in yuan could save 2%-3% on their invoices. Cost advantages and foreign exchange risk mitigation would help the long-term prospects to increase the use of yuan for trade finance purposes.

Gaining Momentum

Indeed, the recent reversal in yuan strength has not dented demand for the currency in trade settlement. On the contrary, it has flourished. Yuan cross-border trade amounted to 437.8 billion yuan in February and 663.3 billion yuan in March, accounting for 28.4% and 32.1%, respectively, of total trade; much higher than the 18% it comprised in China’s total trade in 2013.

According to the Society for Worldwide Interbank Financial Telecommunication, or Swift, the yuan strengthened its position as the seventh-ranked global payments currency with a new record-high activity share of 1.62% in March (from 0.63% in January 2013). It is now ahead of the Canadian dollar (which has a 1.83% share) and the Australian dollar (which has a 1.84% share).

Swift data also indicate that the yuan overtook the euro to become the second-most used currency in global trade finance after the US dollar in December 2013.

With the growing penetration offshore, the regime of yuan internationalisation is gradually taking shape. Although the yuan has not achieved basic convertibility status, many central banks have already started to add it to their official foreign currency funds.


Rankings

The Chinese central bank widened the trading band for US dollar to Chinese yuan in March to 2% around central parity

As of March, the yuan is now the seventh most-used currency for global payments

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Oct 2010 Malaysia’s central bank buy yuan-denominated bonds for its reserve

Jan 2012 South Korea and Japan announce plans to invest in yuan-denominated assets with their foreign reserves

Jul 2012 Central banks of Indonesia, Thailand, Cambodia and Nepal start tilting their reserves to yuan-denominated bonds

Sep 2012 Nigeria’s central bank adds yuan to its reserves and plans to gradually increase its yuan holding to 10%

Apr 2013 The Reserve Bank of Australia will invest 5% of its total foreign reserves in Chinese sovereign bonds

Jun 2013 onwards Abu Dhabi Investment Authority, Government Pension Fund of Norway, Qatar Investment Authority, Kuwait Investment Authority and Temasek are to invest in yuan

Central banks are diversifying holdings into yuan13

This, coupled with the yuan internationalisation process moving towards increasing capital account convertibility, will improve the odds for the yuan to be included in the International Monetary Fund’s Special Drawing Rights (SDR) basket at its next review in 2015. This is necessary for the yuan to be recognised as a truly international currency.

Establishing Free Trade Zones

The process of yuan internationalisation is essentially a process of capital account liberalisation. To mitigate the risks associated with opening the capital account, Beijing plans to test the reforms in the controlled environment of the Shanghai Free Trade Zone (FTZ) before rolling them out nationwide.

The reforms being tested in the Shanghai FTZ include the deregulation of services sectors, the simplification of customs clearance and yuan cross-border trade settlement, interest rate liberalisation, two-way portfolio investment, as well as allowing foreign companies to issue yuan bonds and access to the mainland equity market.

Progress has already been made in the areas of interest rate liberalisation, and capital account and investment deregulation. In particular, there is no longer a cap on the interest rates paid on foreign-currency deposits of less than US$3 million. Through the yuan-denominated intra-group cross-border sweep, companies can now connect funds held within China with their offshore cash pool via a designated account within the zone.

Recently, China’s banking regulator also lifted the loan-to-deposit (LTD) requirement for


14 Process of yuan internationalisation

banks in the Shanghai FTZ. The relaxation signifies that bank branches in the Shanghai FTZ may lend freely without the loan restriction, allowing more capital to support the local economy. The mainland banking industry has long been calling for the relaxation of the LTD requirement, given the increasing pressure on luring bank deposits amid fierce competition from high-yield wealth management products offered by online financial service providers. Meanwhile, scrapping the LTD requirement could rein in shadow banking activities as a lot of off-balance-sheet activities are motivated by restrictions on bank lending.

The initiation of the Shanghai FTZ should not be seen as a policy designed to revive short-term economic growth. If deemed successful, the ultimate goal is to replicate the Shanghai FTZ model nationwide for longer term economic viability. There are reports that Guangdong, Tianjin and Xiamen have made applications to become FTZs as well. With this ultimate goal in mind, one should appreciate the enormous implications the Shanghai FTZ will bring to China’s long-term economic sustainability.

Speeding Up Capital Account Convertibility

In April, the China Securities Regulatory Commission (CSRC) and Hong Kong Securities and Futures Commission (SFC), approved in principle, the development of the Shanghai-Hong Kong Stock Connect, a pilot programme for establishing mutual stock market access between China and Hong Kong. The new programme will be available to individual investors instead of only institutional investors (i.e. QDII, QFII, and RQFII). This again attests to Beijing’s commitment to accelerate the pace of capital account liberalisation.

This policy change will not only have a long-term impact on the assets allocation decisions of Chinese households, but also provide offshore investors an additional avenue to yuan investments. To date, only two offshore yuan-denominated equities have been issued; the Hui Xian REIT (April 2011) and Hopewell Highway Infrastructure (October 2012). The pilot programme allows Hong Kong investors to trade all the constituents of the Shanghai


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Quotas Eligible shares

Southbound Trading Link (or investment to Hong Kong)

An aggregate quota of 250 billion yuan and a daily quota of 10.5 billion yuan

All the constituents of the Hang Seng Composite LargeCap Index and Hang Seng Composite MidCap Index, and shares of all companies listed on both SSE and SEHK

Northbound Trading Link (or investment to China)

An aggregate quota of 300 billion yuan and a daily quota of 13 billion yuan

All the constituents of the SSE 180 Index and SSE 380 Index, and shares of all SSE-listed companies which have issued both A and H shares

Shanghai-Hong Kong Stock Connect15

Stock Exchange (SSE) 180 Index and SSE 380 Index, and shares of all SSE-listed companies which have issued both A shares and H shares.

As yuan-denominated equities become more accessible, the demand for yuan-denominated structured products such as yuan equity-linked note (ELN) and equity-linked deposit (ELD) is expected to surge. By boosting the demand for yuan derivative products, the yuan use for offshore investment settlement purposes can be further promoted. This is an important development to broaden the use of the yuan into the capital account channel.


As yuan-denominated equities become more accessible, demand is expected to surge

International Yuan Usage – Taking the PulseThe DBS Renminbi Index for VVinning Enterprises (DRIVE) is the first index in the industry that is specifically designed to gauge the level of yuan usage, acceptance and penetration among companies registered in Hong Kong, as well as companies’ inclination to use yuan in the future.

Although macroeconomic data on the circulation of offshore yuan are widely available, they are not able to offer an in-depth perspective on the developmental progress of Hong Kong as an offshore yuan centre. By focusing on the level of yuan usage and acceptance among Hong Kong-registered companies, this index aims to serve as the first benchmark to measure the pace of yuan internationalisation in Hong Kong. Policymakers, businesses and investors alike will find this index a useful strategic tool over time.

DBS Bank (Hong Kong) Limited commissioned an independent research house (Nielsen) to compile DRIVE and conduct the related survey on a quarterly basis, starting from the 2012 December quarter. Subsequent index values are released on a quarterly basis and over time will reveal a lot more about the pace of development of Hong Kong as an offshore yuan centre. Corresponding policy recommendations can thus be drawn by analysing the future time series. In future, the index may be extended to cover other countries that are also offshore yuan centres.

March Quarter DRIVE Reading Falls

The latest March quarter reading of DRIVE fell to 57.6 from 58.5 in the December quarter of 2013. The decrease came amid reduced business needs for yuan by local companies. In the March quarter, there was a moderate decline in both the actual and expected usage of yuan customer orders/invoices and trade settlement. In terms of yuan services and products, fewer companies reported that they are currently using or will consider using yuan payment/receivables and yuan trade services than in the previous quarter.

Interestingly, the general decline in the usage of yuan services and products in the March quarter came despite findings showing a slight improvement in business performance in the previous 12 months and a more optimistic business performance outlook for the next 12 months. This means that the speed and depth of yuan development in Hong Kong hinge on factors other than the local economic outlook and the business performance of companies. As Hong Kong is an open economy, its offshore yuan development should be evaluated in the broader context of international yuan development. From this latest survey, it is also apparent that expectations of yuan appreciation play a decisive role in corporate yuan usage and acceptance.

Regarding access to yuan finance, the perception about the ease of access remained fairly constant in the March quarter compared with previous quarters.


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DRIVE aims to serve as the first benchmark to measure the pace of yuan internationalisation in Hong Kong

Expectations of yuan appreciation play a decisive role in corporate yuan usage and acceptance


Yuan Appreciation, Policy Support And Corporate Usage

Six quarters of DRIVE index readings have shown no consistent positive correlation between the state of the economy/economic outlook and the actual/intended corporate usage of yuan. Rather, there is a positive correlation between yuan appreciation expectations and the actual/intended corporate usage of yuan.

Interest in yuan hedging products is likely to continue to pick up amid rising yuan volatility. In March, a total of 19 billion yuan in currency futures was transacted compared with a monthly average of 8 billion yuan in the December quarter of 2013.

Since yuan usage is still at the initial stage, a positive economic outlook alone – without policy catalysts – is insufficient to further incentivise usage.

The potential relaxation of the personal yuan 20,000 conversion daily cap would be a near-term catalyst for Hong Kong’s offshore yuan market, particularly in terms of spurring yuan product innovation and boosting demand for sophisticated yuan products. This, alongside other policy refinements, would increase Hong Kong’s yuan liquidity pool.

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Navigating the Way ForwardChina’s yuan internationalisation project has achieved remarkable progress in a short period of time, taking the currency from relative obscurity on the global stage to an increasingly commonly used currency for trade, investment, and official reserves. What began as a modest initiative in Hong Kong’s consumer banking sector in 2004 has evolved into a measured but irreversible push towards the yuan’s full integration with the global financial system. The next step in this progression is to open China’s capital account to currency conversion. It remains to be seen whether the yuan will become a major fixture of the international economic system.

Based on the experience of internationalising the US dollar, China’s offshore currency liquidity pool will have to grow to 11 trillion yuan for it to achieve one-third of the US dollar’s international status [1]. In other words, the pool needs to grow by eight times from its current size.

To achieve that goal, one plausible option is to allow offshore banks to engage in repurchase transactions in the onshore market and to remit yuan funds offshore. Alternatively, offshore banks can tap the onshore market by issuing bonds and/or certificates of deposit.

Another policy breakthrough is to allow mainland individuals to participate in the yuan-denominated version of Qualified Domestic Institutional Investor program (RQDII2). In this regard, the recently announced overseas securities investment pilot scheme for individuals working in the Shanghai FTZ is a welcome development. To have material impact on offshore liquidity, nevertheless, a geographic expansion of the programme is pivotal when conditions mature.

On the other hand, expanding the scope of the cross-border yuan loans programme could also serve the same purpose. Currently, qualified mainland enterprises are allowed to offer cross-border yuan loans to their offshore affiliated companies. Such an initiative could be extended to financial institutions and could, for example, allow different branches of the same parent bank to offer cross-border yuan loans among themselves.

As offshore liquidity grows, the range and sophistication of financial assets in addition to the variety of yuan activities can be further developed. Subsequently, through the multiplier effect, the size of the offshore yuan liquidity pool will be largely expanded.

China’s yuan internationalisation project has taken the currency from relative obscurity to an increasingly commonly used currency

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Notes1] According to a report published by the Hong Kong Financial Services Development Council,

November 2013

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Disclaimers and Important Notices

The information herein is published by DBS Bank Ltd (the “Company”). It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee.

The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof.

The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies.

The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation.


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