Tuesday, September 6, 2011

New Milestone For RMB Global Circulation and Internationalization

In our earlier article, we did introduce briefly about the latest development of offshore Renminbi (RMB, or called Yuan, or CNY) centre in Hong Kong, through the New Policies that are Benefiting Both Hong Kong and China. Today, we would like to explore more details about each of these important policies which should also be regarded as major milestone towards RMB internationalization.

Those new policies relating to improve convenience in cross-border RMB investment, circulate RMB globally and promote RMB internationalization are:

(1) RQFII (RMB Qualified Foreign Institutional Investors): This new RQFII program opens up an important investment channel for RMB inflow back to the onshore asset market. However, since the offshore RMB in Hong Kong already totaled a record RMB 553.6 billion at the end of June, the size of the RQFII program (only RMB 20 billion) is indeed too small. In addition, although offshore investors eagerly seek to make profits from RMB appreciation, they face a problem of having fewer RMB investment options in the offshore RMB market. Current offshore RMB investors can only put their money into the low-yield RMB-denominated bonds or even RMB deposits.

Because the financial institutions in offshore market have very low incentive to offer higher RMB interest rates to investors, the yield of RMB-denominated bonds in Hong Kong is always less than the yield of RMB bonds in the mainland China with the same maturity period. Some economists may even described RMB holdings in Hong Kong were just "dead" money with very low liquidity. Although the new RQFII policy may be initially designed to narrow down the price differences in securities market, we expect that the introduction of RQFII with this small size may just encourage investors to put their RMB holdings in the onshore bond market rather than in the onshore securities market.

(2) FDI (Foreign Direct Investment): Now there has still only one RMB-denominated stock in Hong Kong (please read: Stock Analysis of Hui Xian) and further expansion is necessary. Since the new FDI channel allows RMB flowing back directly to the onshore asset market, it does provide incentive for more companies to raise RMB IPO (Initial Public Offering) in Hong Kong. This new FDI program will certainly expand the size of offshore RMB capital pool in Hong Kong and, eventually make the city the only real and paramount offshore RMB centre in the world. FDI should also improve convenience in cross-border RMB investment and reduce loss in RMB currency exchange for investing in the onshore asset market.

(3) RMB-denominated Bonds: Under the new policy, China Ministry of Finance will start issuing RMB treasury bonds regularly in Hong Kong and the Chinese central government will make it a long-term institutional arrangement. The size of bond issuance will also be increased gradually in order to add depth to the growing offshore RMB market and to provide a benchmark yield curve for other RMB-denominated bonds. This arrangement not only will expand sales of RMB-denominated bonds in the city, it will also expand the size of offshore RMB capital pool as a whole.

(4) ETF (Exchange-Traded Fund): This new ETF channel can close the loop for the RMB global circulation. Under the new policy, cross-listing ETFs, or called "mini through-train" program, will be allowed in Hong Kong, Shanghai and Shenzhen stock markets. This ETF program is a replacement for the so-called "through-train" program (let mainland China individuals to directly buy H.K. securities) obsoleted by January 2010. However, the quota of this new ETF program still remains unknown. Unless the ETF quota is again too small, it should help to reduce the price differences between the H-share (for Chinese enterprises listing offshore in Hong Kong) and A-share (for Chinese enterprises listing onshore in Shanghai or Shenzhen) securities markets.

Closed loop RMB circulation via RQFII FDI Bonds ETF

New milestone completing flow channels for closed-loop RMB circulation: inflow (yellow) to the mainland China through RQFII, FDI and Bonds; outflow (green) to Hong Kong through ETF

These new policies, not only reflect a big symbolic step to raise the international profile of RMB, they also push for greater international use of RMB with more investment options available. In addition, the new policies can reduce China's dependence on the USD, after S&P's (Standard & Poor's) cut the U.S. long-term credit rating to AA+ on 5 August 2011. China will then be less affected by the increasingly volatile and weaker USD.

Just as a preliminary investment tips for our readers, the new policies should benefit a range of RMB-concept related stocks including the mainland securities brokerage companies and the Hong Kong Stock Exchange (HKEx stock code: 388.hk), although many policy details have not yet been announced. HKEx said immediately on 18 Auguest that it has been in joint-venture talks with the mainland China's stock exchanges in Shanghai and Shenzhen for new product development relating to indexes or equity derivatives. Another very obvious gainer is the Bank of China (Hong Kong Branch) which should get at least some benefits as there will surely be more RMB business available (BOCHK stock code: 2388.hk).

After all, RMB internationalization requires open-up of three major areas: capital market, interest rate, and exchange rate. As long as the capital market in the mainland China is still not completely open, RMB internationalization can only be processed with gradual easing in RMB capital controls. The above set of new policies is absolutely a milestone for relaxing limits on cross-border investment flows, and for expanding RMB circulation channels between Hong Kong and the mainland China. It also signals that the Chinese central government starts to kick off the engine of RMB internationalization which should help to reduce the increasing pressure of China's huge foreign exchange reserves.

For Hong Kong, the set of new policies (RQFII, FDI, Bonds, ETF etc) is not only just a gift to support Hong Kong role as an offshore RMB centre, it also reinforces the principle of "always open-up to HK first" and clears some people's previous doubt that Hong Kong could possibly be marginalized during the rapid development of the mainland economy. The world is ever changing and Hong Kong must concentrate on catching this golden opportunity, as what the Central Bank Governor Zhou Xiaochuan said: it is now the time that China needs Hong Kong to help circulating RMB globally and promoting RMB internationalization.


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