This article originally appeared in Investment & Pensions Asia.
By Iain Mills
26 August 2011
There have been more Chinese currency-related developments this week, including an announcement by the Ministry of Commerce that RMB-denominated foreign direct investment into China may be allowed as soon as September. This follows on from Chinese Vice Premier Li Keqiang’s visit to Hong Kong last week, a move some are comparing with Deng Xiaoping’s legendary tour of the South in 1992.
Li announced a range of measures to support the development of the SAR as an offshore renminbi (CNH) centre. “The two most notable aspects of Li’s visit to Hong Kong were a commitment to steady capital account liberalization and, more significantly, the fact they came from China’s likely next Premier,” Ashley Davies, a senior economist and foreign exchange strategist at Commerzbank AG, tells IPA. “We see this as an endorsement by a key individual in the reform process. It is evidence that the process can continue under the new leadership, and the transition may not be as disruptive as some have predicted for CNH development.”
Among the measures, Li announced a RMB20 billion pilot scheme to allow foreign investors to buy mainland stocks and bonds, the nationwide expansion of the RMB trade scheme, the expansion of central government bond issuances offshore, a Hong Kong equity-based Exchange-Traded Fund and market entry for Hong Kong insurers into the mainland. Li also announced a pilot permitting non-financial firms to raise capital offshore, a privilege previously reserved for mainland banks.
“The new guidelines, in essence, will greatly simplify not only the procedures to raise capital from the CNH pool but also the procedures to bring the proceeds back for non-financial investment,” according to a note by Z-Ben Advisers.
“For the investment management sector, short-term opportunities will likely be limited to the alternative space, specifically private equity and venture capital investments. Even though PE/VC investments will still have to obtain approval from the MoC, raising RMB funds offshore might be easier for many foreign General Partners compared to doing so domestically or conversion through the nascent Qualified Foreign Limited Partnerships programme.”
“Getting direct access to A-shares, however, would require similar procedural clarification from both China Securities Regulatory Commission and State Administration of Foreign Exchange. We expect these new regulations to come out, albeit in a pilot programme, sooner rather than later,” Z-Ben says in the note.
The flurry of announcements follows a summer of uncertainty in the CNH markets. Following 12 months of rapid, largely uncontrolled growth, Beijing took steps to tighten market control. A moratorium was placed on mainland companies seeking financing offshore, and greater efforts were made to ensure offshore-onshore flows are for legitimate trade settlements only. In June, CNH deposits collapsed to RMB4.8 billion against the 12 average monthly increase of RMB46 billion, a decline attributed to changing trade flows between Hong Kong and the mainland.
“The government has been trying to push back and put up barriers to onshore inflationary pressures of late,” William Nobrega, managing partner at the Conrad Group, says. “For example, it has not been allowing property bonds for investment in China, and there are issues regarding repatriation of funds. But this should change once inflation is in check, and there are signs that this point is approaching. Moreover, Chinese policymakers will be increasingly concerned by the U.S. and global slowdown and this could alter the tightening agenda.”
Nobrega also strikes a bullish tone on the prospects for further liberalization. “We expect the RMB to become fully convertible and backed by a basket of precious metals. CNH will be the cornerstone of this evolutionary process. There may be bumps along the way, but really this is a once in a life-time opportunity and we are living history.”
Others, such as Joel Hu, a currency specialist at the Chinese Academy of Social Sciences, takes a more cautionary tone. “It is important not to misunderstand Premier Li’s visit. It does not mean faster liberalization of the capital account. China won’t deviate from its path of gradual reforms and it will be a long time before we see full liberalisation.”
“There is obviously large demand for CNH from investors as an appreciation play. But China must balance offshore and onshore interest. If the CNH market doesn’t develop rationally, this could have damaging effects for onshore economic development. Domestic economic stability will remain the top priority,” Hu adds.
In the mean time, the renminbi’s attraction as an appreciation play looks set to remain, both short term and directionally, according to Commerzbank’s Davies.
“It’s instructive that the yuan’s recent appreciation has occurred while other currencies are depreciating,” he observes, referring to the Chinese currency’s 0.9% appreciation against the U.S. dollar in the last month. “This is in stark contrast to 2008 when the response to global volatility was to reinstate the peg. In our view, this is to take advantage of a relatively low level of speculative global capital flows. Under normalised conditions, there could be a lot more hot money, so China wants to take advantage of this window to allow a period of appreciation.”
In the longer term, Davies is also more bullish than consensus. “We are calling for accelerated capital account liberalisation in late 2012 to early 2013. A major part of my thinking when advising a client to be long RMB on a two-year time-frame would be that a period of rapid appreciation is very likely.”
Still, “there won’t be any short term reduction in ambiguity. Until we reach full liberalisation of the capital account, there will conflicting policy views on the desirability of CNH,” he warns.