With the changes to the renminbi exchange rate regime introduced in July this year, we can expect to see the development of a renminbi forward market for risk management.
Readers are aware of the renminbi non-deliverable forward (NDF) market. For entities outside the Mainland, as there is no proper means for buying or selling renminbi for forward settlement, the NDF is a convenient way of hedging or betting against a possible change in the renminbi exchange rate. This market has been in existence in Hong Kong and elsewhere for some time, with activities increasing along with the market attention given to the then possibility (now a reality) of a revaluation of the renminbi exchange rate. But it has been very much a market for currency players wanting to take a speculative position on what seemed to them to be an inevitable event. There was little interest or participation from those that might have a need to hedge, for example, those with manufacturing operations on the Mainland and those engaging in external trade with the Mainland. In any case, the NDF market is not particularly liquid and the bid-and-offer spreads are probably prohibitively high for those with genuine hedging needs. Before the changes to the exchange rate regime were introduced, the renminbi exchange rate had also been very stable, obviating the need to hedge, despite the declared intention of the Mainland authorities to introduce greater flexibility.
Now that the changes to the renminbi exchange rate regime have been introduced and the exchange rate does move around somewhat, the need for those having a day-to-day operational exposure to the renminbi to hedge against exchange risk has been brought to the fore. And in recognition of the need to encourage the development of financial instruments suitable for the purpose of managing exchange rate risks, the People’s Bank of China has introduced new measures to develop a renminbi forward market on the Mainland. The new arrangements will allow those who have a need to manage exchange rate risks on the Mainland to interact among themselves by bidding and offering renminbi for forward settlement, and it is hoped that an active forward market would emerge by itself over time.
But there is not yet a renminbi forward foreign exchange market for hedging exchange rate risks arising from flexibility in the renminbi exchange rate incurred by entities outside the Mainland, notably those in Hong Kong, one of the Mainland’s largest trading partners and major source of direct investment. The prospect of increased genuine hedging needs of this group of entities is likely to lead more banks to act as market makers for the existing NDF market in Hong Kong. By narrowing the bid-and-offer spreads and lowering transaction costs, these market makers would help facilitate market liquidity and encourage participation by non-bank entities. This in turn would help the renminbi NDF market to grow in depth and breadth, and to evolve from a market just for financial professionals to one catering also for the genuine needs of enterprises. Over time, it may even converge with the on-shore forward foreign exchange market. I am hopeful and confident that the market will find its own solution to this.
So far, the day-to-day fluctuations in the renminbi exchange rate against the US dollar have not been very large. The biggest we have seen was 60 pips, or 0.07 per cent, on 11 August 2005, which is lower than the maximum of 0.3 per cent allowable move on a single day. One may therefore question the need for a hedging facility at the moment. But I suspect this number, and the cumulative number in a particular direction over a period of time, are likely to get bigger as the new system is bedded down and as all concerned get accustomed to life with a flexible exchange rate. Let us therefore get on with it.
Joseph Yam
18 August 2005
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