As China’s portfolio account further opens for inflows through the renminbi qualified foreign institutional investor (RQFII) scheme, onshore and offshore interest rates will converge again, after widening since the end of February, according to ANZ.
Since late February 2013, the onshore renminbi (CNY) as appreciated as capital inflows returned and policymakers expressed concerns about inflation pressures. More recently, speculation that the People’s Bank of China (PBoC) might widen the currency trading band has reinforced appreciation expectations, said Wei Liang Chang, FX strategist at the bank.
“As a result, investors have become more willing to hold the offshore renminbi (CNH) which led to a decline in interest rates across the CNH curve. Twelve month offshore FX swap rates have declined by 100 basis points (bp) since the start of the year to around 2.10% currently,” he said.
“Meanwhile, onshore rates (measured by 12-month repo swaps) have been stable, leading to the widest differential between onshore-offshore 12 month rates since April 2012.”
In light of this, it is surprising that onshore companies have not taken advantage of the lower rates to raise more capital offshore, but this is due to the fact that State Administration of Foreign Exchange (Safe) approvals to repatriate the proceeds onshore are hard to obtain, said Chang. However, as more RQFII and QFII quotas are granted, offshore funds will increasingly find their way onshore.
The size of the RMB deposit base in Hong Kong was around Rmb650 billion (US$105.36 billion) in February. As such, an additional RQFII quota issuance of up to Rmb200 billion this year has the potential to drain substantial RMB liquidity from Hong Kong.
“Assuming that RMB deposits continue to grow at the same average monthly growth rate of the past two years, it should reach Rmb825 billion by the end of the year. If the planned RQFII quotas are disbursed in full this year, [it will imply] a net tightening of offshore RMB liquidity conditions,” said Chang.
“On top of being a drain on liquidity, offshore investors could demand higher CNH rates, given that they can choose to invest in higher-return onshore Chinese assets across the risk spectrum, as compared to being limited by the current status quo of mostly investing in deposits.”
The increase in offshore CNH rates depends on whether there are more RMB funds willing to invest onshore than granted quotas. If this is the case it will help cap CNH rates to levels that are in line with CNH appreciation expectations.
“However, if the constraint is not binding and all funds that want to enter into mainland markets are able to do so, the risk-free rate that offshore investors demand should move up to the onshore risk-free rate. This view is subject to the availability of market participants who are willing to borrow CNH offshore to invest in higher yielding onshore RMB assets,” he said.
If holders of CNH assets do not want to swap them for onshore RMB assets, a yield convergence will be limited and appreciation expectations will continue to impact rates.
“In short, the final offshore CNH rate will be a tussle between appreciation expectations and RMB asset returns, with the outcome likely to be somewhere in between (but higher compared to current levels),” said Chang.
“We do not view RMB inflows to the onshore market to be large enough to influence onshore rates downwards given the size of the onshore market.”