In our previous article, RMB internationalization – a bumpy ride (Part 1), we revisited the factors contributing to the emergence of an internationalized currency as well as the main benefits and drawbacks associated with it. In this second part, we will first recall what China has undertaken in the past few years in order to promote its currency on the international stage and then focus on Hong Kong as the main offshore RMB center.

As mentioned in the first part, China won’t be able to internationalize its currency without making it fully convertible and reachable to the rest of the world in the long run. On the other hand, it can’t get this done overnight without exposing the country’s economic stability at risk. The government therefore aims at doing it gradually and carefully. The establishment of the “Renminbi Qualified Foreign Institutional Investor” commonly known as RQFII is a good start to achieve this goal.

Indeed, it will enable a limited amount of investors to invest in mainland China while limiting excessive volatility. The Figure 1 below summarizes the quota authorized by PBoC to foreign countries. The quota enables foreign entities to invest in mainland Chinese assets previously restricted to domestic investors only.

Figure 1: RQFII Quota as of end of 2014 (RMB Billion)

RQFII Quota as of end of 2014 (RMB Billion)

Source: PBoC, author

As we can see, Hong Kong enjoys the higher RQFII quota, far ahead of European countries or even Singapore which is trying to compete hard with Hong Kong to take the lead as the main RMB offshore center. We can clearly distinguish three levels: 1) HK, 2) France, Germany, South Korea & UK and 3) Australia, Canada, Singapore and Switzerland. GDP size and economic tie seem to be the main factors that determine the amount of quota authorized. As the time goes, quota size will be increased and new countries will be eligible.

The table below summarizes the Bilateral Swap Agreements (BSAs) currently effective between the PBoC and other central banks, aiming at promoting trade settlement in RMB and lower transactions costs.

Figure 2: RMB Bilateral Swap Agreement (RMB Billion)

RMB Bilateral Swap Agreement (RMB Billion)


Source: PBoC, author

Not surprisingly, the APAC region, due to its proximity and higher economic linkage, represents more than half of the total BSAs. Europe, the Middle East and Africa enjoys also a relatively high quota through the following key partners the ECB, Russia, Switzerland & UK. Finally, North and South America enjoy only a small quota, even though Canada, Brazil and Argentina are other key trading partners of China, especially in the raw materials and commodities industries.

However, no quota has been negotiated so far with the United States. Obviously, the U.S. wants its currency to remain the top spot so it has absolutely no incentive to agree or to promote a rival’s currency. It worth to recall that a currency is also a powerful tool when it comes to geopolitical considerations. Should China continues to reform and to open up, we can expect the amount of BSAs to increase in the coming years. These previous general observations and comments were made about the RMB internationalization through the onshore market. The second part of this article will now focus on the offshore market.

In this article, Hong Kong will be taken as the offshore RMB center for obvious reasons (similar culture, close economic ties…). As the RMB continues to rise in the offshore market, we should observe key developments, namely the amount of RMB deposits offshore and the amount of assets denominated in RMB sold in Hong Kong and finally the the convergence of the CNY/CNH. First let’s have a closer look at the RMB deposits in Hong Kong.

Figure 3: RMB deposits in HK

RMB deposits in HK

Source: HKMA, author

Following the financial crisis (2008) and the PBoC’s initiative, the amount of RMB deposits has progressively increased from $30 billion in 2007 to $1 trillion in 2014! This increase took place in tandem with a growing number of institutions authorized to collect RMB. However, we can see that this trend has stabilized and even lost momentum as the total RMB deposits actually dropped in the last months of 2015. The coming months and quarters will tell us whether this development is punctual or structural.

We should keep in mind that the RMB has historically been under very tight control by the Chinese government. In the recent years, notably due to China’s economic rise in terms of GDP (but not only!), investors have been bullish believing that because the RMB was undervalued it could only go up. These bold expectations have been a main catalyst to invest and hold RMB offshore, most obviously because the onshore access is restricted.

However, the recent concerns about the Chinese economy have changed this paradigm: investors are now looking to exit and even sell the offshore RMB short. This partly explains why the amount of RMB deposits in Hong Kong has dropped recently. Again, the key question remains: is the recent decrease an isolated event showing investors’ nervousness about the RMB volatility or is it the signal that more profound structural changes are taking place? In other words, is this high volatility justified or not?

Another aspect to look at in order to get a better picture of the development of the offshore RMB in Hong Kong is the money market settled in RMB. The figure 4 includes certificates of deposit, commercial papers, corporate bonds and notes, exchange fund bills and notes, and other money market and capital market bearer instruments as specified by the Hong Kong Monetary Authority (HKMA). While this graph focuses on short term maturity assets, the figure 5 aims at getting an insight of the long term maturity assets.

Figure 4 & 5: Money Market assets (RMB-denominated) in Hong Kong & Offshore RMB issuance

Money Market assets (RMB-denominated) in Hong Kong & Offshore RMB issuance

Sources: HKMA, BOCHK, author

First of all, we can observe that the orange line (representing the aggregate of CMU issued in Hong Kong since 2011) has significantly increased, showing the willingness and success of the Chinese government to gradually develop the offshore RMB center in Hong Kong.

Nonetheless, since 2014, the trend has clearly stabilized and even weakened a bit. Taking a closer look highlights that most of CMU issued are short term maturity up to 3 years. The long term maturity issuance’s are still marginal, which is normal since money market assets are usually short term maturity assets.

However, Figure 5 gives a better picture about what’s going on in terms of long maturity. The observation is straightforward: it shows that bond issuance is losing momentum after having doubled from 2011 to 2014. We should also note that a lot of Chinese companies raised money in HK since they could not do it in mainland. An increase in bond issued from foreign companies would be a good and healthy sign of the offshore bond issuance. Again, offshore RMB market is still at its early stages so it is premature to draw definitive conclusions at this point. However, we should definitely keep a close eye on these development.

Let us now have a look at the currency itself by analyzing the spread between CNY (onshore) and CNH (offshore).

Figure 5: Spread between CNY (onshore) & CNH (offshore)

RMB Spread between CNY (onshore) & CNH (offshore)

Source:, author

From January 2013 to July 2015, we can see that both the CNY and the CNH have been trading relatively closely. During this period, the CNY has appreciated and the CNH has appreciated even more, underscoring the fact that the CNY was actually undervalued. Nevertheless, since March 2014, it seems that the trend has reversed and the depreciation that occurred in August 2015 reinforces this observation. The volatility, which was until then quite narrow, increased significantly in August. If we consider the CNH to be more fairly valued, we must thus conclude that the CNY is now overvalued.

This spread indicates that at least one currency is not traded at the right market price. Some might say that the CNH is under too much depreciating pressure due to short sellers while other may argue that the slowdown of the Chinese economy doesn’t justify a such a large depreciation of the CNY. Even if the two sides may be right, the divergence in prices reflects different perceptions and expectations.

Regardless of who is right or wrong, one thing is certain: volatility will have to come down at some point at the expense of someone, either investors or the PBoC. The USD/CNH 12 months Forward is traded at around 6.89 as of end of January 2016, much lower than the CNY spot at around 6.57. This forward price clearly reflects that investors price the CNY at a much lower level than it is currently priced.

Since the RMB will join the Special Drawing Rights (SDR) basket in October 2016, the PBoC will do whatever it can in order to stabilize its currency. Beyond this technical consideration, we know that a currency is a paramount component of economic growth. It should therefore be priced accurately and be stable in the long run. If fluctuations and volatility are essential to reflect the market-driven forces, in some cases, excess of volatility can be unjustified and very disruptive for economic stability. As a result, the central bank should do all it can to preserve the currency’s stability.

In 2015, more than USD 1 trillion left China. This amount, representing a bit less than one third of China’s current foreign exchanges reserves, intensifies the downward pressure on the RMB. Simultaneously, the currency depreciated a lot in August 2015 and this might happen again later this year. These two elements are self-reinforcing and act with a leverage whether the trend is upward (capital inflows coupled with currency appreciation) or downward (capital outflows coupled with currency depreciation).

In the past few months the PBoC has burnt a lot of cash (USD 500+ billion) in order to defend its currency. This situation clearly can’t last forever since credibility and foreign exchange reserves are not unlimited. The PBoC is massively intervening on the offshore market by creating a cash squeeze, triggering a rise in interest rates and thereby increasing the cost to borrow the currency by short sellers: a good example would be what happened on January 12th when the overnight rate reached 60%!

The recent developments of the offshore RMB market in Hong Kong illustrate how difficult it can be for a central bank to either internationalize its currency or simply pursue multiple goals at the same time. The IMF’s decision to give a green light for the RMB to be part of the SDR basket, a very selective currency club, is a huge step. The Washington-based institution thus appears confident in China and is giving its full support to the country. In return, China has clearly worked hard and initiated meaningful reforms such as lending rate liberalization, the Shanghai-Hong Kong stock market link, and the Shanghai Free Trade Zone, just to name a few. Yet, as we have seen above, the hardest part is actually yet to come.

About Steve Nguyen

Analyst based in China for 4 years, with significant analytical skills in Macroeconomics, Financial Markets and the Chinese economy.