We concede it is early days yet – and hazard to add again that the renminbi, off which CNH takes life, is the globe’s most political currency – but the portents and possibilities the development of this market implies could be staggering.
We recite again our core view that offshore renminbi trading domiciled in Hong Kong relates more to the regionalisation of a Greater China renminbi than the more-popular (media-driven) notion of a globalised renminbi. The market’s core users in the early days likely – though not exclusively – will be the mainland Chinese. The depth and breadth of trading will be dependent on the build in renminbi deposits in Hong Kong – for it is off that base which the deliverable forward curve will be priced.
But if our short visit to the territory reveals anything, it is the fact that the sleepiness that has come to accompany Hong Kong dollar currency board band trading is about to give way to a ‘Brave New World’ of Chinese financial market development – and all the sundry and complex changes to Greater China’s existing financial market architecture that may imply over time.
We have long quipped in conversation with colleagues and clients that we are in the opening minutes of a three-hour movie when it comes to market liberalisation in Asia. Yet if the CNH’s development proceeds at half the clip some of the more optimistic projections we encountered in our Hong Kong meetings suggested, that estimate may be about to jump a good half hour or so.
As of October 2010, renminbi deposits in Hong Kong ran at Rmb217.13 billion, ($32.5 billion) rising Rmb67.8 billion ($10.1 billion) – or 45.4% – on a monthly basis. The development of Hong Kong’s renminbi deposit base will prove integral to the evolution of the Hong Kong-based renminbi deliverable market – especially so since the deliverable forward curve is priced off the renminbi deposit base in the territory.
The general consensus is that renminbi deposits in Hong Kong are about to go parabolic, with some Rmb30 billion ($4.5 billion) a month net flowing into the territory over the balance of 2010 – taking the current Rmb217.13 billion ($32.5 billion) deposit base to roughly Rmb280 billion ($42 billion) by the end of 2010.
A rough surveying of the anticipated size of renminbi deposits in Hong Kong in one year’s time vary between Rmb500 billion and Rmb1 trillion ($75 billion to $150 billion). But the logic underpinning even the most optimistic estimate doesn’t sound far fetched, all things being equal. Consider: China has 30 provinces and a total deposit base of roughly Rmb70 trillion ($10.5 trillion). If you take into account Hong Kong’s roughly Rmb1.5 trillion-equivalent GDP, the territory’s renminbi deposit base should theoretically grow to Rmb2.5 trillion ($374.3 billion) eventually. What are the strategy implications of all of this? Well, we admit we might be seducing hyperbole here, but if this plays out like the optimists submit, the US dollar/renminbi non-deliverable forward (NDF) market is dead.
Over time – and as the CNH market builds – the Hong Kong dollar will fade away, too, though practitioners see this as an evolutionary event and intrinsically complex. After all, what to do with Hong Kong dollar-denominated debt? How does the market go about pricing risk as a consequence of a US dollar de-link? How does Hong Kong equity valuation deduce a risk-free rate for discount factor modelling as CNH and renminbi bond markets grow and increasingly become capable of intermediating capital and providing for some sort of price discovery – however guided by China’s “not so invisible” hand?
As for the CNH market itself, we have, and continue to build, short US dollar positions out the curve. Low volume in the market is a risk, but we think we can unwind the position over three trading days if need be. Basis risk is a bit of a worry in shorter-dated tenors, too – but trading the deliverable forward to compress toward the NDF in the one-year sector is attractive.
And the best hedge for the position? It may very well be to simply be long US dollar/Hong Kong dollar – a positive carry proposition.
A brave new world, indeed – and though its nexus may in time be in a CNH market in Hong Kong, Asia has to be watching and wondering: how do we deal with this beast that is China? The region guards its currencies against untoward appreciation, forever fearful of losing market share to aggressive mainland exporters. But it is the magnet that is the People’s Republic in the emerging market complex that requires a thoughtful policy response, particularly as China moves ever more upscale in its value-added production.
We are well beyond the issues that surround the hollowing out of Asia’s industrial base to take advantage of low-cost manufacturing on the mainland, in short. We’re evolving into something else which will be, at once, both symbiotic and competitive.
A key question then: How will Asia deal with the giant sucking sound that the capital draw a prospective Greater China Co-Prosperity Sphere represents when all is said and done? Our guess: through greater capital market reform that courts higher levels of transparency than China itself seems willing, at this point in time, to consider.
Indeed, the seeds for it may already have been sown. Korea’s move to court membership in Citigroup’s World Government Bond Index is a case in point. Talk now centres on building out a viable bond repo market. Deliverability in Korean won possibly waits in the wings. The same may be true in Malaysia of the Malaysian ringgit, we’d offer, as the region at large works overtime in building out local currency interest rate capacity which is deep enough and broad enough to sufficiently absorb not just incoming cash flow but the excess cash already on hand.
This movie’s plot line is taking shape. It is exciting to be working the evolving Asia story.
Chin Loo Thio is a senior FX and interest rate strategist and Gao Qi is an associate of rates strategy research with BNP Paribas corporate and investment banking.
This article was initially published in the FX Report 2010, which was published together with the December 2010/January 2011 issue of FinanceAsia magazine.