IN 2003, the People’s Bank of China and the Hong Kong Monetary Authority came to an agreement to allow Hong Kong banks to conduct business in renminbi. Since then, the offshore renminbi market has expanded rapidly but has created a complex currency situation: one country with two systems, three currencies and four yield curves (see chart, right).
While the renminbi trades on the Chinese mainland and offshore as the same currency, it trades at different rates.
This discrepancy between the respective rates was engineered through regulation in order to cater to the different supply and demand conditions of the offshore and onshore markets. However, alongside the traditional renminbi and the offshore currency, there is the dollar settled non-deliverable forward as well as the trade-settlement exchange rate used by offshore corporations. This trio of currencies are all renminbi backed.
The offshore currency is tender on the mainland, provided that it can be transferred through the official channels. As a result, the difference between the valuation of the offshore and onshore renminbi is dictated by the ease with which cross-border transfers can be made. The NDF curve behaves as a futures curve, linking itself with the onshore renminbi market. According to Daniel Hui, senior FX strategist for HSBC Global Research: “The key is that the offshore renminbi is effectively a separate currency that, while it does allow exposure to the onshore renminbi, it is not a perfect proxy to either the onshore renminbi or the NDF curve.”
In the wake of Standard and Poor’s decision to downgrade US government debt, the Communist Party via the Xinhua News Agency commented that there should be “a new, stable and secured global reserve currency”, so one would expect to see the expansion of the offshore renminbi to be as carefully controlled as its onshore currency, as part of China’s long-term plans of internationalising and turning the renminbi into a reserve currency. But, as Hui points out: “We expect the development of this market to be calibrated by policymakers’ level of comfort that they can understand the market, can monitor and regulate it, and be sure that it does not unduly destabilise other related markets.”