Peking over the top of China’s Great Currency Wall

THOUGH there is constant talk of China’s rise, currency investors often find themselves frustrated by the apparent wall between them and the Chinese currency. However that doesn’t mean that those wishing to take a position on China’s currency, the renminbi (RMB) are without options.

On first inspection, the Chinese currency seems as rigidly controlled as that of an oil exporter pegged to the dollar. However, the restrictions enforced by the People’s Republic have relaxed significantly over the last 40 years. From the 1970s until 1997, non-Chinese nationals were not even allowed to use the RMB and its denomination the yuan. They were instead issued with foreign exchange certificates which remained in circulation until the mid 1990s. From 1997 until 2005, the yuan was pegged at 8.28 to the dollar. Since then it has appreciated by just over 17 per cent in small, tightly controlled increments.

These small increments aren’t enough for some, who plead that the Chinese should “responsibly balance” the exchange rate and further revalue its currency. They point to the boom in Chinese exports, especially those to the US and argue that there would not be such a large trade imbalance between the two economic giants were it not for China’s manipulation of its exchange rates. Despite this, China doesn’t appear to be in any real hurry. According to Michael Hewson, market analyst at CMC Markets: “I don’t foresee currency relaxation in the near future. Although there is pressure to revalue the exchange rate from the US, they will do so in their own time. You could argue that they will want to let the currency appreciate. China has historically been running a surplus against which it has faced pressure from the G20 to ‘sort out the trade imbalance’. However, with it running a deficit last year, China will be more resistant to pressure to float the currency.”

Craig Farley, investment manager for the Ashburton Chindia Equity Fund plays down talk of rapid deregulation “I would love to be able to say that China will open up soon, however that talk is more hype than reality. It is a process that will take decades rather than happening tomorrow. We are seeing some movement in the corporate bond market, however this market is an immature one, with most financing in China coming through bank loans or retained earnings.”

CORPORATE MCBONDS
Despite the lack of signs that the RMB will become a free-floating currency soon, there are still options for investors to get exposure the Chinese currency.

Last year, Standard Chartered launched from Hong Kong an RMB corporate bond for McDonald’s. They declared that it was the first RMB bond launched for a foreign multinational corporate in the Hong Kong debt capital market.

The notes, with a 3 per cent coupon rate and an issue size of 200m yuan, were targeted at institutional investors and had a maturity date of September 2013.

The launch of McDonald’s RMB corporate bond could well signal the beginning of a new funding channel for foreign investors wishing to access renminbi exposure.

Previous to the RMB bond, the bank has already introduced RMB denominated structured investments. Stating that he hoped that the bond issued would help accelerate Hong Kong’s development as a RMB offshore centre, Benjamin Hung, the bank’s chief executive officer in Hong Kong said “We are delighted with the pace of the RMB market development process in Hong Kong and will continue to expand our RMB product offering.”

CHINESE DENOMINATED ETFS
Though RMB-backed corporate bonds are in their infant stages, they are not the only way of gaining exposure.

According to Nick Beecroft at Saxo Bank, for the near future, exchange-traded funds (ETF) could be the best way forward: “We are on a gradual path towards a relaxation of currency restrictions in China. The decoupling of the offshore renminbi in Hong Kong from the onshore equivalent was a step along that road, but it will be at least 5 years before we will be contemplating convertibility. When the market does open up, it will be as big as any other in the world. In terms of gaining exposure to the Chinese currency, the best approach is via ETFs and funds. The Chinese currency-denominated funds are based on non-deliverable forwards and seek to replicate physical exposure to the RMB.”

ETF Securities offers one of the market’s only renminbi-denominated ETFs. They give the option of going short or long on the Chinese currency versus the dollar. Based on the non-deliverable forward derivatives market, the fund tracks the expectation of an increase or decrease in the renminbi around a 0.5 per cent trading band.

China’s conservative policy of currency management may actually serve as a positive for investors. According to Martin Arnold, analyst at ETF Securities, “if you look at previous periods of this policy, we have seen increases of 5 to 7 per cent per annum of the dollar-RMB exchange rate. Since the middle of last year, we have seen the pace of revaluation return to pre-2008 levels of around 4 per cent. Given this, there is not a lot of expectation of revaluation of the currency over the next 12 months. For this reason, now could present an attractive time for investors to get into the NDF-based ETF market while expectations are low and then profit on the upturn.”

While we may be a while off a free-floating currency in the country that is expected to emerge as the world’s largest economy, now seems like it could be a cheap time to buy RMB-backed ETFs and gain from Chinese growth.