Hong Kong’s renminbi trade-settlement scheme might be growing quickly, but it faces an uncomfortable truth: deposits in Hong Kong renminbi, or CNH in bankers’ jargon, heavily outweigh the city’s available pool of renminbi assets by more than four to one. That leaves many would-be opportunists with a tough question: what to do with their renminbi?
CNH deposits have increased to Rmb407 billion ($62.2 billion), as of February 2011. Opportunities to invest CNH, however, are limited principally to renminbi-denominated Hong Kong-issued bonds. But with a total outstanding amount of about Rmb95 billion of these so-called dim sum bonds, they account for less than a quarter of CNH deposits.
Ben Chan, a senior vice-president in business strategy and planning at HSBC, said that expected appreciation of the currency, combined with the cost savings of settling in renminbi, will drive growth despite lack of investment avenues. “In the long run, the use of renminbi for trade settlement will not solely rely on the appreciation play; it will be triggered by the convenience of transaction costs.”
Trade figures would seem to support this view. About Rmb500 billion of global trade was settled in renminbi last year. This amounts to only about 2% of all trade — a tiny proportion given the mainland’s position as the world’s second-biggest economy and largest exporter. Not surprisingly, analysts expect this proportion to increase dramatically.
“People think that the renminbi has been freely tradable for five years, but in fact it really only started last summer, which is not a long time,” said Philippe Jaccard, managing director and regional head of liquidity and investments at Citi.
Indeed, for the many firms with long-term plans to develop their mainland China businesses, using renminbi makes perfect sense, but adapting to it can be a slow process for some. “Their intention is not to play with the currency, but to restructure their supply chains so they can use the renminbi more efficiently,” said Jaccard. “But, to do this, there are a lot of parties they need to bring together first, and terms and conditions of contracts may have to be changed, so it takes time.”
Additionally, though still relatively small, the dim sum bond market is growing fast, with 26 new issuers selling Rmb25 billion of bonds between January and late April of this year. According to Vishal Goenka, head of local currency credit for Asia at Deutsche Bank, once outstanding issuances grow to about $20 billion, more global players will have to engage in the CNH bond market, which will likely result in exponential growth, providing a sizable outlet for companies’ CNH deposits. Indeed, Goenka expects outstanding issuances to treble by the end of the year from about $5 billion today, suggesting that the market could reach the $20 billion target as early as next year. “As the credit market is still the only offshore renminbi asset class, from a macroeconomic point of view investors and market players can’t afford to ignore it.”
A recent Deutsche Bank report suggests that market innovations will also encourage Hong Kong renminbi denominated assets. The report identified renminbi foreign direct investment, which is expected to be permitted soon under new regulations, as a key driver. This should result in more renminbi lending, bond issuance and Hong Kong renminbi IPOs.
So-called third-party use will also help CNH liquidity — this is when foreign companies borrow renminbi in Hong Kong and then convert it into foreign currencies for use overseas, hedged by a cross-currency swap. Deutsche predicts that Hong Kong banks could, as a result, enjoy a fourfold increase in net interest margins within two years. By the end of 2012, CNH assets could grow tenfold to Rmb700 billion, compared to an expected fivefold increase in CNH deposits, said the report.
Such an increase would result in CNH deposits hitting Rmb2 trillion, which could leave firms with idling CNH. While there is broad agreement that capital account liberalisation is the ultimate aim of the Chinese authorities, opinions vary as to whether the success of the trade-settlement scheme depends on it.
“I think trade settlement will be enough to drive CNH on its own,” said Goenka. “It is a fact that China’s capital account is not open and that may limit short-term growth, but it should not take away from the fact that there is a lot of business going on that needs to be restructured, and this will not happen overnight.”
But others say greater capital account access will boost the scheme. “The authorities may need to consider a limited QFII [qualified financial institutional investor] scheme to supply the offshore market with renminbi if, as appears is occurring, the renminbi trade-settlement scheme becomes more balanced as between payments from the mainland to Hong Kong and payments from Hong Kong to the mainland,” said Tim Condon, managing director and head of research, Asia, ING Financial Markets.
But limited access may not cut it, said Ashley Davies, Commerzbank’s emerging market Asia senior economist and FX strategist, who said capital account liberalisation is a far more urgent requirement. “We came to the view in October last year that the renminbi trade-settlement scheme only makes sense if China intended to pursue capital account liberalisation. Otherwise we felt that the project would eventually fail,” he said. “If we do not see a greater connection between offshore renminbi deposits and onshore capital markets in China, then current enthusiasm for investing in low-yielding CNH deposits will fall.”
Much of the market has settled on 2020 as the date for capital account convertibility, though it could occur within five years, according to Deutsche. But Davies sees it coming far sooner. “Many people are saying that capital account liberalisation is a generational exercise — that it will take 10 to 15 years, but we think we will see accelerated capital liberalisation much sooner, possible by early 2013 or even late 2012.” This would be enough time to prepare for currency volatility, and to avoid asset bubbles causing damaging capital outflows at a time when the capital account is being opened.
Companies settling trade with renminbi should take note, for if Davies is right, a swathe of renminbi investment opportunities might become available much sooner than the market expects.
This story was first published in the Rmb Report 2011 supplement to the May 2011 issue of FinanceAsia magazine.