The use and circulation of renminbi outside the Mainland has increased considerably since the approval by the State Council in July 2009 of the pilot scheme for renminbi cross-border trade settlement. With strong support from the Central People’s Government, an offshore renminbi business centre is gradually taking shape in Hong Kong. Renminbi deposits in Hong Kong jumped from RMB60 billion yuan early last year to over RMB540 billion yuan by the end of May 2011, of which 70% are deposits by enterprises and the remaining 30% by personal customers. With this rapidly expanding liquidity, Hong Kong has also become a centre for the issuance of offshore renminbi bonds, or “dim sum” bonds. Sixteen issuers offered bonds worth a total of RMB36 billion yuan last year, and the figure this year is set to mark a record.
There are two schools of thought on the development of our renminbi offshore business: one believes the renminbi has started a rapid process of internationalisation and it will soon become a major reserve currency, challenging or even replacing the US dollar as an international currency in the not-too-distant future, while the other says the development of our offshore centre should not be too hasty, lest it undermine the status of the Hong Kong dollar and adversely affect the Mainland’s macro-economic and monetary management. I think these views call for more elucidation of the current situation.
What is renminbi regionalisation / internationalisation?
Different people may define the internationalisation of renminbi in different ways. It can be argued that the use of renminbi to settle bilateral trade alone is only an initial step towards “internationalisation.” Trade is a bilateral economic activity, and it would be natural and normal for China, the world’s second largest economy and trading nation, to use its own currency for settlement of trade transactions. The framework introduced in 2009 has enabled China to use its own currency to settle external trade. From this perspective, it represents a “normalisation” of the cross-border use of renminbi. China’s trading partners are all over the world, and enterprises anywhere, including but not limited to those in Asia, now have the option to use the renminbi to settle cross-border payments with China. Renminbi “regionalisation” is therefore not a description that can represent the full picture. However, the renminbi will be truly internationalised only when it becomes a major settlement currency for international trade and for holdings of foreign reserves by other countries, and when a substantial amount of financial assets denominated in renminbi are held and traded in the international financial markets.
Should substantial amounts of renminbi flowing out of the Mainland be of concern?
Some people are concerned about the rapid increase in the renminbi deposits in Hong Kong since the middle of 2010 to over RMB540 billion yuan by May this year. But, putting things into context, renminbi deposits in Hong Kong amount only to 0.72% of the RMB77 trillion yuan in renminbi deposits on the Mainland. This percentage will remain small even if renminbi deposits here continue to increase.
In the early stage of the renminbi’s internationalisation, it is necessary to have a sufficient net amount of renminbi flowing out of the Mainland. Otherwise, no renminbi would be accumulated outside the Mainland and, as a result, no offshore market could be formed. Currently this net outflow of renminbi is achieved mainly through trade, with the amount of renminbi paid by Mainland enterprises for imports to the Mainland exceeding the amount of renminbi paid by overseas enterprises for exports from the Mainland. The net outflows then become renminbi deposits held offshore. Since overseas buyers of the Mainland’s exports usually have less usable funds in renminbi than US dollars, coupled with the expectation of the renminbi appreciating, overseas enterprises do not presently have a strong incentive to opt for renminbi to pay for the Mainland’s exports. On the contrary, there are incentives for suppliers and sellers of products to the Mainland to receive renminbi payments. I expect the net outflow of renminbi from the Mainland through the trade channel to continue for a fairly long time.
Is formation of renminbi offshore centres an expected development?
With renminbi circulating and being accumulated outside the Mainland, there will naturally be demand for offshore renminbi services that banks can provide. But the scale of business conducted in a place or a financial centre will depend on the size of its customer base and the extent of its business reach, as customers can always choose where to open accounts and manage their funds. In general, enterprises expect banks to provide services that are convenient, reliable, safe and efficient. Hong Kong’s renminbi offshore platform has been able to develop rapidly precisely because of its world-class financial infrastructure, and its long-term role as a gateway for trade and investment between the Mainland and the rest of the world.
Hong Kong serves corporations based both in Hong Kong and overseas. Of the renminbi deposits held by corporations, 16% belong to overseas enterprises. I expect more overseas companies will use renminbi for settlement of trade and investment, although not all of them would open accounts in Hong Kong directly; some may choose to open renminbi accounts with the banks in their own countries, which then make use of Hong Kong’s renminbi platform. These overseas banks can use two different channels to conduct cross-border payments.
First, overseas banks can choose to provide their customers with services such as cross-border trade settlement, buying and selling of renminbi and deposit-taking through a correspondent bank in Mainland China. Secondly, they can also make use of Hong Kong’s platform to conduct these businesses. These two channels exist in parallel and are not mutually exclusive. In practice, many banks are actually using both channels simultaneously. Hong Kong is the offshore renminbi centre capable of offering one-stop services, providing much flexibility and choice for fund allocation, buying and selling of renminbi, hedging, bank financing, debt issuance and financial investment products, compared to placing renminbi funds with Mainland correspondent banks. This is a very attractive proposition for many overseas enterprises.
I believe the existing two channels are capable of supporting the development and promotion of offshore renminbi businesses around the world. Among the some 170 participating banks in Hong Kong, more than 150 are branches or subsidiaries of foreign banks or overseas branches of Mainland banks, covering more than 30 countries in five continents. The correspondent bank channel can also support renminbi businesses worldwide. For the US, while an enormous number of offshore US dollar businesses are operated by financial centres around the world, the settlement of US dollars overseas is basically conducted through correspondent banks in the US.
How should we view the link between renminbi onshore and offshore markets?
As renminbi is not freely convertible and there are restrictions on capital account transactions, the onshore and offshore markets are separate. But the separation should not be seen as absolute. For example, some people have suggested that renminbi funds that have flowed out of the Mainland should remain circulating outside the Mainland indefinitely. But this is quite impossible. At present, renminbi funds that reach offshore markets eventually return to the Mainland even after many rounds of intermediation. This is because there is not yet an economy outside the Mainland where renminbi is used so extensively that funds can be accumulated and recycled for use indefinitely.
In other words, for the successful internationalisation of the renminbi, the onshore and offshore markets must be linked with each other. Three "bridges" now link the onshore and offshore markets:
(1) Trade items – China’s external trade in goods and services can be settled in renminbi and funds can flow rather freely in and out of the Mainland for this purpose. As pointed out above, outflows are presently larger than inflows, providing the necessary liquidity for the formation of the renminbi offshore market. While this "bridge" under the trade account can be further expanded and improved, it is already very wide and capable of providing smooth passage for China’s continuously expanding trade to be settled in renminbi. (2) Direct investments – At present, under the capital account, foreign enterprises making direct investments in the Mainland are subject to regulation and approval. It has been the arrangement that, after foreign enterprises have remitted US dollars or other foreign currencies, approval by the State Administration of Foreign Exchange is required to convert them into renminbi for payments. Similarly, Mainland enterprises making direct investments overseas can only do so in foreign currencies. The People’s Bank of China (PBoC) announced new measures in January this year to allow Mainland enterprises to remit renminbi out of the Mainland for outward direct investments. Foreign enterprises making direct investments on the Mainland may also remit renminbi onshore for payments, subject to approval on a case-by-case basis. Recently, many issuers remitted renminbi funds raised from the issuance of renminbi bonds in Hong Kong to the Mainland for payment of expenditure arising from their direct investments on the Mainland, thereby eliminating the process and costs of currency conversion and reducing the foreign exchange risks that may otherwise have been involved. Hence, this bridge is still under construction: the part on outward direct investment has been built, but the part on foreign direct investment is not yet completed. The PBoC has indicated that it is working with authorities on a new set of measures, which can hopefully be introduced within this year. This will help to greatly expand direct investments on the Mainland by foreign enterprises using renminbi funds they own or have raised. This is an important step to complete the circulation loop of renminbi funds in the offshore market. Not only will it promote foreign direct investments, thereby supporting the real economy, it will help reduce the pressure on the accumulation of foreign reserves arising from the inflow of foreign capital into the Mainland. (3) Financial markets – Linking the capital markets on the Mainland with international markets is an important step to gradually remove the restrictions on capital accounts. This must proceed at a measured pace, as there are still many imbalances and uncertainties in the international financial markets. A financial crisis in one place can easily be amplified and transmitted to other parts of the world through international financial markets, causing massive flows of capital and possible threats to global financial stability. However, domestic capital markets cannot be completely separated from international financial markets when the capital account is opening up. It is not possible to rely on just the trade or direct investment channels for renminbi funds that have flowed to the offshore markets to be re-circulated back to the Mainland. While the offshore markets will develop all kinds of financial products, the Mainland is still the primary market where the value of renminbi funds can be preserved or enhanced. Hence, with risks properly controlled, it is necessary to build a link between the onshore and offshore renminbi financial markets in a gradual and orderly manner. The PBoC has allowed three categories of institutions outside the Mainland (including offshore monetary authorities, renminbi clearing banks, and participating banks of renminbi businesses) to invest in the Mainland’s interbank bond market. The HKMA has also been provided with a quota of RMB15 billion for making investments in this market. The proposal to allow offshore renminbi funds to invest in the equity and bond markets on the Mainland through the “Renminbi Qualified Foreign Institutional Investors” (RMB QFII) is still being considered by the Mainland authorities.
I believe there should be links and, at the same time, some separation of the renminbi onshore and offshore markets. As the Mainland’s foreign trade and investment continue to expand rapidly, the bridges connecting the onshore and offshore markets should be expanded and strengthened. At the same time, some adjustment of this process may be needed in view of practical experiences, so the development can take place in a gradual and controlled manner to help support the real economy, and to be consistent with the policy and pace of moving towards full convertibility of the renminbi and the gradual opening up of the capital account.
When these bridges become wider and stronger, fund flows between the onshore and offshore renminbi markets would be more or less unrestricted, and that will also be the time the renminbi has essentially become freely convertible and most capital account transactions have been liberalised. At that time, the onshore and offshore markets will be closely linked, and prices in the two markets will broadly converge.
Will prices in offshore markets affect those in onshore markets and macro-economic management on the Mainland?
I do not think we need to worry too much about this. With the separation of the two markets, fund flows into and out of the Mainland are controlled by the width of the bridges and measures that manage the volume of the flows. The renminbi exchange rate and interest rates in Hong Kong are determined by changes in supply and demand in Hong Kong’s offshore market. For example, in the second half of October 2010 when demand surged suddenly and supply became inadequate, the offshore renminbi exchange rate strengthened to about 1,500 pips (about 2.5%) at premium over the onshore exchange rate. As a result, however, more enterprises were willing to sell renminbi, thus increasing the supply of renminbi, leading to a softening of the exchange rate. Similarly, when the supply of renminbi was larger than demand last December, the offshore exchange rate was 200 pips in discount to the onshore rate. These phenomena indicate the prices in Hong Kong’s offshore market are driven by its own supply and demand. Given that the size of the offshore market is small and there is separation between the onshore and offshore markets, the renminbi exchange rate in Hong Kong will not create any significant impact on prices in the onshore market. For the same reason, while renminbi deposit rates in Hong Kong are lower than those on the Mainland as there are still limited outlets for renminbi funds in Hong Kong, the lower offshore rates did not drag down the onshore rates.
Theoretically, Mainland enterprises should have incentives to seek financing in Hong Kong as the costs for issuing renminbi bonds are much lower than those on the Mainland. At present, non-financial institutions on the Mainland are not allowed to issue renminbi bonds in Hong Kong. Even if they were allowed to do so, they would have to go through Mainland approval processes and could not remit the renminbi back to the Mainland at will. Therefore, it will not be easy for Mainland enterprises to take advantage of the lower costs of financing in Hong Kong’s offshore market to get around macro-economic management measures on the Mainland.
There is also some concern that the increasing amount of renminbi funds outside Mainland China will suddenly flow back to the Mainland one day, thus undermining its financial stability. However, the direction of fund flows is subject to a range of domestic and external economic factors, rather than the circulation of renminbi outside the Mainland. The pressure of fund inflows will manifest itself in the form of foreign currencies even when there is no renminbi outside Mainland China. The key is to implement appropriate and targeted arrangements to monitor and manage cross-border fund flows in all currencies.
Will the development of Hong Kong’s offshore renminbi business centre affect the status of the Hong Kong dollar?
On the question of whether the renminbi could replace the Hong Kong dollar, I pointed out in an earlier inSight article there should be little cause for concern. The increase in renminbi circulating in Hong Kong does not necessarily imply “currency substitution”. Hong Kong is a shopping paradise, and merchants are willing to provide convenience to tourists from the Mainland by accepting renminbi. It does not mean they have lost confidence in the Hong Kong dollar; and they have not preferred renminbi to the Hong Kong dollar as a means of payment when they conduct business with Hong Kong residents. The increase in renminbi deposits should also not be interpreted as the Hong Kong dollar being substituted or marginalised. The fact that during the renminbi’s internationalisation process a large amount has accumulated in Hong Kong reflects the attractiveness of Hong Kong as the offshore renminbi business centre. The remarkable growth in renminbi deposits and other financial intermediation activities is a reflection of the development of Hong Kong as an international financial centre and an offshore renminbi centre. It will not undermine or weaken the status of the Hong Kong dollar.
Norman T. L. Chan
Hong Kong Monetary Authority
19 July 2011