Renminbi liberalisation opens up hedging opportunities

In April, the People’s Bank of China (PBOC) widened the RMB trading band with the US dollar from within 0.5% to within 1%. The currency can now float intraday within this 1% range but data from the Hong Kong arm of Japanese bank Mitsubishi UFJ Group (MUFG) shows that there is still a strong policy incentive to fix the currency away from the spot to control the band. However, the fixing is increasingly being undermined by the spot price moving away, prompting authorities to intervene directly to maintain the 1% range.

“In the first few months that the band was widened the authorities thought they could have their cake and eat it by operating a wider band, fixing it and have the market follow along but that has not happened,” says Clifford Tan, East Asian head of global markets research at MUFG in Hong Kong.

“If you intervene too far away from where markets want to trade then you encourage capital outflow. If the Chinese authorities make small adjustments then it might be easier to manage their currency at this stage,” he says.

The PBOC has also lowered rates to stimulate the economy in response to a domestic slowdown with one-year loan rates lowered by 31 basis points to stand at 6% and one-year deposit rates lowered by 25 basis points to stand at 3%. Year-on-year GDP growth is 7.6% according to official figures.

One consequence of this slower pace of growth compared with a decade of nearly double-digit economic expansion has been seen with currency futures pricing in depreciation in the Chinese currency over a medium-term horizon. Non-deliverable forwards (NDFs) are pricing in depreciation of 1% over the next 12 months according to Nathan Chow, Hong Kong-based economist at DBS but he believes the Chinese currency will reach 6.4 versus the dollar in the third quarter before coming back to 6.35 by end of year.

Outflows

The depreciation factor has resulted in “capital seepage” according to Tan at MUFG whereby some of these funds leave the system. “The gap between onshore RMB deposit rates and onshore US dollar deposit rates has narrowed so there is now more incentive to hold dollars than RMB onshore as people realise that the RMB may need to be weaker to stimulate exports,” he says.

And with the RMB no longer a one-way bet, the prospect of two-way hedging has become a reality for the first time especially as multinational corporations are increasingly being paid in RMB. According to data provider Swift, more than 10% of China’s trade is now settled in its own currency.

“We are seeing the first shoots as companies see the opportunity to hedge. We are noticing more activity between the CNH and US dollar and also euro and CNH and over time hopefully there will be more in the yen, which just started a few months ago,” says Tan.

He adds that while multinational companies may look to hedge the currency fluctuation, Chinese companies are more likely to change the composition of their currency holdings primarily between the RMB and US dollar.

However, Dennis Wong, co-head of emerging markets for China at JP Morgan in Shanghai, says that NDFs are being used to lock in future price fluctuations and that forex options are being used by some mainland corporations with a contingent exposure, for example, companies that are unsure of future trade volumes due to eurozone uncertainty.

“If a company has a projected five billion dollars’ worth of trade business in three years’ time but that assumption is dependent on Europe and there is concern that the order will drop to three billion dollars, then three billion dollars can be hedged with currency forwards and for the other two billion dollars currency options can be used to lock in the price and manage the forex risk,” he says.

The gap between onshore RMB deposit rates and onshore US dollar deposit rates has narrowed