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Why the Chinese currency took the spotlight

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IMAGE: A customer holds a 100 Yuan note at a market in Beijing. »


China's market turmoil since the start of the new year has put the spotlight on a not-much-noticed quirk of trading the mainland's currency: the offshore yuan doesn't always want to stay in tune with its onshore peer.

What's the difference between the onshore and the offshore yuan?

While China has slowly been opening its markets, the country still doesn't allow a completely free flow of capital across its borders. The onshore yuan, also called the renminbi, is constrained by a trading band: China's central bank, the People's Bank of China (PBOC), lets the yuan spot rate rise or fall a maximum of 2 percent against the dollar, relative to the official fixing rate, which is set daily.

But the offshore yuan, abbreviated as the CNH, trades freely, based on market forces.

The offshore market was created in 2010 to help "internationalize" the currency for purposes such as hedging and investment, but not trade. Trade settlement can be done through a designated clearing bank in Hong Kong.

Why were China's policymakers so concerned?

In November, the International Monetary Fund (IMF) agreed to add the renminbi to its Special Drawing Rights (SDR), a type of international reserve asset. It will join the euro, yen, pound and dollar in the reserves basket. The yuan will have about an 11 percent weighting in the SDR. The renminbi's addition will take effect in October.

That means the renminbi is now officially recognized as a reserve currency, in a reflection of the changing dynamic of the world's economy.

But one of the requirements of the SDR is that the onshore and offshore yuan need to converge toward a free floating rate. As markets sold off this month, the two currencies diverged.

The dollar was fetching as much as 6.7511 yuan offshore on January 7, compared with 6.5926 yuan onshore, a large spread. At Wednesday's close, the dollar was worth 6.5648 yuan offshore and 6.5743 yuan onshore.

What did China's policymakers do?

The PBOC intervened in the offshore market, sopping up yuan there. That caused the cost of borrowing offshore yuan in Hong Kong's interbank market to surge earlier this week as the amount of spare renminbi in the banking system declined. The Hong Kong Interbank Offered Rate (Hibor) tied to the offshore yuan surged as high as 67 percent for overnight lending, the highest since it was established in 2013. That put the squeeze on speculators who were selling the yuan short on expectations the currency would fall further. Speculators may have also been purchasing yuan in the offshore market and then selling it in the onshore market to take advantage of the arbitrage.

"We believe China is sending a strong message to speculators and trying to stabilize renminbi depreciation expectations," HSBC said in a note Tuesday.

While the CNH overnight Hibor had already eased to 3.60550 percent by Thursday, that doesn't mean offshore yuan are about to become plentiful.

"If it is the PBOC's intention to keep CNH Hibor high to make it expensive to short the offshore renminbi, then renminbi liquidity is unlikely to be forthcoming," HSBC said in a separate note Wednesday. Those higher offshore rates aren't likely to be transmitted to onshore channels or to have much impact on the real economy, HSBC said.

"Neither Hong Kong's economy nor China's economy is heavily reliant on CNH Hibor funding," it said.

Offshore-yuan Hibor borrowing likely isn't all that large. Bank of China estimated in March that daily volumes in the offshore yuan interbank market were $5 billion to $8 billion on average. That's a fraction of the more widely-followed Hong Kong dollar-tied Hibor.


Article Credit: CNBC

Updated 2 Years ago

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