China’s leaders are well aware that it needs a more flexible framework to be able to compete in the years to come, despite the country’s impressive growth. China is transforming its financial system, having already made great strides to liberalise its economic system. This is a delicate operation and reform will take time.
A series of moves have already been made, including the widening of the renminbi trading band against the US dollar in April 2012. The People’s Bank of China has also allowed banks the flexibility to offer rates at 1.1 times the official deposit rate and to lend at a floor lowered from 0.9 times to 0.7 times the official lending rate, the first step towards liberalising interest rates. More moves will likely follow in the coming years.
Banks have dominated China’s financial landscape but that needs to change. In addition, the funding markets in China remain domestically focused. This distorts the cost of capital, and prevents a rapid transition to the levels of corporate governance China needs.
It is welcome news that China is actively supporting the development of the ‘dim sum’ offshore renminbi bond market
Global investors want a robust regulatory regime aligned with international standards. It has effectively taken the developed market framework and Hong Kong’s expertise and regulation and overlaid a renminbi-denominated bond market. This has enabled global issuers to become more comfortable with issuing renminbi bonds, and with investing in the bonds of Chinese companies. They are able to deal in Hong Kong and more recently London.
The onshore market is also being opened up at an accelerated pace. Until recently, the only offshore investors who could access the onshore market were central banks and renminbi clearing and settlement banks. In January 2012, the Renminbi Qualified Foreign Institutional Investor (RQFII) pilot scheme allowed some Hong Kong unit trusts to invest onshore. More recently, the older QFII scheme, formerly largely confined to equities, was liberalised to allow investment in the China inter-bank bond market. Separately, onshore access was extended to allow access by international organisations such as the International Bank for Reconstruction and Development and also to some insurers who underwrite renminbi insurance policies in offshore markets but need the deeper onshore Chinese market to hedge their liabilities.
The opening of the bond markets to global investors is not something that can be switched on or off in isolation from the rest of the financial system. If China is to internationalise its currency, open its capital account, attract inward investment, promote global competition and fund its next expansion phase, all of these need to happen together. Each is dependent on all the others, and so we are seeing progress on every one. It seems a likely consequence of financial reform that access to the onshore market will be granted to more and more investors over time.
At present global bond markets have many issues: persistent economic weakness, and minimal yields among them. Investors are increasingly attracted to new markets for diversification. As China plays an increasing global role, so could a freed Chinese bond market.