China’s plan to create a special zone to experiment with currency convertibility in Shenzhen will impact Hong Kong’s CNH market.
The new measures will enable Hong Kong banks to lend renminbi directly to companies in Qianhai Bay – a new economic zone on a peninsula across the water from Hong Kong – according to Chinese state media. Beijing unveiled the details on June 29 as Hu Jintao, Chinese president, visits Hong Kong for the 15th anniversary of the handover of the city from Britain.
“The announcement is another step towards renminbi convertibility,” said Dariusz Kowalczyk, senior economist and strategist at Crédit Agricole in a note released on June 29. “It lacks many details and seems to be a small-scale move, but highlights the determination of Chinese policymakers to open the capital account.”
The French bank expects full convertibility to occur within the next five to 10 years, but this could happen sooner with the emergence of Qianhai as a special economic zone.
There will be near- and long-term implications on this new development, which includes the impact on Hong Kong’s offshore renminbi market, also known as the CNH market.
“We think that issuance of dim sum bonds and taking out renminbi loans in Hong Kong means more outflow of funds from the CNH market,” said Kowalczyk. “In the medium-term, this will drive up CNH money market rates there, push up CNH cross-currency swaps (CCS) and dim sum bond yields, increase CNH forward points and help the CNH spot move to a premium versus the CNY spot.”
Moreover, Crédit Agricole highlights that China’s non-deliverable forwards (NDF) market will be affected as Beijing proceeds to use Qianhai as a currency testing ground for the offshore renminbi market and a pioneer of the currency’s free convertibility.
“Full convertibility would likely be negative for the renminbi as it would trigger portfolio diversification outflows,” said Kowalczyk. “Thus, the renminbi may fall in the longer-dated NDF market if investors expect faster convertibility.”
An NDF is a cash-settled, short-term forward contract on a thinly traded or non-convertible foreign currency, where the profit or loss at the time at the settlement date is calculated by taking the difference between the agreed upon exchange rate and the spot rate at the time of settlement, for an agreed upon notional amount of funds.
The renminbi has fallen 1.1% since the start of 2012. The Chinese currency, which continued to ease from a seven-month high of 6.3827 per dollar, closed at 6.3584 on June 28. Offshore, one-year USD/CNY NDF contracts rose to an average of 6.4196 from 6.4165 on June 25.
Qianhai was first established in 2010 and is due for completion in 2020.