Yuan faces appreciation trend in long term, says Citigroup
Hong Kong expected to maintain offshore role despite recent sharp drop in trading
The yuan will encounter a trend of appreciation rather than depreciation in three to five years, says Citigroup managing director and chief China economist Liu Ligang.
“There is not much depreciation pressure for the yuan,” he said, tipping the currency to slide to between 6.5 and 6.6 against the US dollar by the end of this year – from 6.45 at present – but to rise in the long run following further opening of the mainland’s capital market.
Mainland China’s trade surplus was around US$600 billion last year, and Liu said it would not have reached those heights with a substantially overvalued currency.
“China’s deficit in capital and financial account was partly due to the increase of ‘net errors and omissions’ since the beginning of 2014,” he said. “That’s why the central bank tightened the regulations on capital account, especially on the capital outflow through illegal channels such as underground banks.”
The deficit in net errors and omissions exceeded US$400 million in almost every quarter in the past two years, which was more than double the average in the previous two years according to data on the State Administration of Foreign Exchange’s website.
“The mainland will not have much capital flight pressure if such omissions are reduced,” Liu said. With the mainland’s foreign exchange reserves showing signs of stabilising in the first quarter this year, market expectations of unilateral yuan depreciation would weaken, he added.
The opening of the mainland’s bond market – the world’s third largest – to foreign institutions in February would attract global fund managers to allocate assets there because mainland bonds had higher yield spreads than many overseas products.
“The stabilisation of US dollar and the yuan in recent months has provided a great chance for the Chinese central bank to launch more opening policies,” Liu said, “It’s very clear that the opening [of the bond market] aims to reduce expectations of the yuan’s unilateral depreciation.”
And rather than grappling with the risk of capital flight, Beijing would come under more pressure from capital inflows in the long term, Liu said.
“There’s US$36 trillion of pension funds under management by 13 countries in the Organisation for Economic Cooperation and Development (OECD), among which the yuan-denominated assets are almost zero,” he said. “A small portion of allocation in onshore bonds could bring much inflow.”
Paulus Mok, Citigroup’s country treasurer in Hong Kong and head of markets for Greater China, said it had helped many foreign central banks and sovereign wealth funds build bridges to enter the mainland bond market, adding purchases would increase in the second half of the year.
Mok said most institutional investors would choose bonds with high credit ratings, so the recent defaults of some onshore bonds would not hinder their entry to the onshore bond market.
Liu said the People’s Bank of China would have to abandon its fixation with the stability of the yuan if it wanted to pursue an independent monetary policy and open the capital account, citing the “Impossible Trinity” theory.
“The PBOC’s communication with the market must be better in the future, as the volatility of the yuan should converge with its peers if it becomes a major currency,” he said.
The yuan has been stable recently, and with the trading spread between onshore and offshore yuan narrowing since mid-February, offshore yuan trading in Hong Kong has dropped sharply.
“The average daily activity of offshore yuan trading of our bank has fallen 20 per cent compared with the beginning of the year,” Mok said, while adding that he believed trading had nearly hit bottom and would increase as mainland firms embarked on more mergers and acquisitions.
“Offshore activities will continue even if the onshore market is fully opened ... but the scale of each offshore market will change,” Mok said.
He said concerns that Hong Kong’s position as an offshore yuan centre would disappear after the mainland fully opened its capital market were unfounded, but it would be a case of “survival of the fittest” for Asia’s three offshore yuan markets: Singapore, Taiwan and Hong Kong.
“The trading scale of each market will change in the future,” Mok said. “We don’t really need too many ‘offshore yuan centres’. Every market will fight for themselves. But I believe Hong Kong’s scale will even grow bigger.”