City's offshore yuan pool under threat from trade discount
Weak inflows and expanding channels for renminbi outflows are adding to challenges faced by Hong Kong banks in keeping offshore yuan
Hong Kong's offshore yuan pool risks drying up as offshore paper trades at its widest discount in more than two years, prompting mainland importers to avoid coming to Hong Kong to settle their cross-border trades.
Apart from weak inflows, expanding channels for renminbi outflows from the city - through dim sum issuance, the renminbi qualified foreign institutional investor (RQFII) scheme and the migration of liquidity to other centres - are adding to the challenges faced by Hong Kong banks in keeping yuan deposits.
The offshore yuan had been trading at a premium to its onshore counterpart most of the time since the beginning of cross-border trade settlement in 2009. The price advantage has been a key driver in turning the city into the world's largest offshore yuan centre, with 1.2 trillion yuan (HK$1.51 trillion) in deposits. However, this driver is losing steam.
The offshore yuan (CNH) traded at a discount to the onshore currency throughout September, with the gap at one point reaching almost 300 pips for the first time in two years.
The last time the offshore yuan traded at such a wide discount was between September 2011 and September 2012, when the city's deposits shrank by as much as 82 billion yuan.
"We underestimated how much the offshore pool of CNH would be squeezed as we hoped that a foreign exchange rebound would attract more flows to the offshore market," said HSBC analyst Crystal Zhao. "However, CNH spot met a sell-off when offshore investors priced in a dimmer outlook following the gloomy August figures."
One indirect reason for the worsening situation was the pro-democracy Occupy Central protests, which broke out on September 28, with political uncertainty adding extra volatility to the foreign exchange market.
The absence of deposit growth is already being felt by the city's top lenders. Standard Chartered increased its one-year renminbi deposit rate on Friday to 3.4 per cent, the highest among its peers. Nanyang Commercial Bank, Bang of China (Hong Kong) and Citibank have also increased rates in the past month to retain liquidity.
The absence of deposit growth is bound to change market dynamics in the near future.
Cheaper offshore yuan means it is more economical for an importer to switch renminbi into dollars on the mainland than to bring yuan to Hong Kong to settle a trade. That is set to reverse the offshore yuan deposit growth pattern in the city over the past five years, when more money was paid out to the offshore market than went into the mainland, as importers switched to renminbi much more keenly than exporters.
Corporate clients' weakening appetite for switching to yuan invoicing is already evidenced by declining use of yuan in cross-border mainland trade. Only 16 per cent of the mainland's cross-border trades were settled in yuan in August, a three-month low. More than 80 per cent of cross-border trades were done with Hong Kong.
One solution, Zhao said, would be to remove the daily 20,000 yuan conversion limit for Hong Kong residents, as retail deposits accounted for around 30 per cent of renminbi deposits as of January. Yet some market watchers are worried that Beijing may postpone such policy relaxation given the protests.
"The offshore market needs more than merchandise trade flows," Zhao said. "When CNH spot traded at a premium to CNY, as it did for most of the year, goods and service trades added liquidity to the offshore pool. But this driver is losing steam, so others are needed."
The offshore yuan spot rate weakened 0.45 per cent against the US dollar in September, the biggest monthly decline in half a year.
