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07 Aug 2013

Focus on renminbi

Paul Mackel

by Paul Mackel

Head of Asian FX Research, HSBC

Focus on renminbi

Currency purchases by the People’s Bank of China slowed significantly in the first four months of the year

The squeeze in China’s onshore liquidity and the subsequent slowing of the renminbi’s appreciation have put increased focus on the currency and the path of further foreign exchange reform, liberalisation and internationalisation. This article answers key questions on China’s currency.

What caused the onshore liquidity squeeze in June 2013 and how did it impact the renminbi?

This squeeze – where the seven-day interest rate spiked at 12.5 per cent – was caused by seasonality, tighter regulation and smaller investment inflows. Liquidity in China’s money market tends to tighten towards the end of June when regulators check the loan-to-deposit ratios of banks. Fiscal and corporate tax payments are also due in July. However, in June 2013 the rapid expansion of the shadow banking system compounded things.

Tighter regulations also contributed to the squeeze. Currency purchases by banks and the People’s Bank of China slowed significantly in the first four months of the year, suggesting efforts to curb speculative inflows are taking effect. The central bank also chose initially not to inject additional liquidity, as it normally does. Together these factors caused concern in the market, sending the interbank overnight rate soaring.

This should lead to the currency being convertible and propel deeper renminbi internationalisation

What is the impact of current monetary policy on the renminbi?

Although the central bank acted as the lender of last resort during the squeeze, it maintains that monetary expansion can support economic growth. However, policymakers have subsequently put more focus on a “prudent monetary policy”. That means banks deleveraging, an end of easy money for sectors with overcapacity, support for GDP growth, and keeping credit lines open for smaller companies.

A prudent money and credit policy should be positive for the renminbi in the long term, because it ensures the health of the banking system and makes growth more sustainable. However, at the moment, prudent policy also means slower growth and easing inflation.

How did the removal of the lending rate floor impact the renminbi?

The removal of the lending rate floor in July 2013 signals that reforms toward greater capital-account openness will continue. Ultimately this should lead to the currency being convertible and propel deeper renminbi internationalisation, as Qu Hongbin, HSBC’s Chief Economist for Greater China, notes. Interest-rate reform should help increase the renminbi sensitivity to onshore interest rates over time.

And more reforms are on the horizon, including to the foreign exchange regime. It has long been an important policy goal to make the renminbi rate in offshore markets more market driven.

How has the regulatory framework changed for the renminbi?

Regulatory changes this year offer further support to renminbi internationalisation and clarify the broader regulatory environment for the currency across its different jurisdictions. These measures are consistent with economic rebalancing and structural adjustment, encouraging renminbi usage in trade settlement and direct investment, as well as deepening capital-account convertibility.

Will slower economic growth impact renminbi internationalisation?

Sentiment has been negatively affected by the slowdown in growth but more balanced flow pressures may actually be seen as a window of opportunity to advance renminbi internationalisation and other foreign exchange reforms.

How do offshore regulations differ from one location to another?

In general the regulations in the different renminbi centres are similar, to ensure maximum market efficiency and liquidity. Offshore renminbi is freely transferable between all centres and there is no price difference across offshore centres.

This research was first published on 25 July 2013.

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