Comments on Settlement Infrastructure for Local Currency Internationalization by Changyong Rhee and Lea Sumulong Paper R. Sean Craig

IMF Resident Representative in Hong Kong HKIMR Conference on Currency Internationalization Hong Kong, December 11 th , 2012

If you build a state-of-the-art RMB settlement system; will they come?

What role does the settlement system play in RMB Internationalization?

RMB Internationalization in Hong Kong depends on Mainland China’s capital account opening • Partial opening of the capital account supported development of offshore RMB products and markets • Supply of offshore RMB liquidity (i.e. RMB deposits) created by outflows from mainland (i.e. trade settlement) • Usage of offshore RMB boosted by opening up of FDI channel to mainland and R-QFII • Offshore RMB markets critical to trade and manage risks needs infrastructure to support liquidity • Full convertibility unnecessary but some cross border flows and arbitrage needed to sustain market development • Infrastructure for RMB settlement important but what else is needed?

Focus of China’s capital account opening shifts to liberalizing cross-border RMB flows ...

2007 Mainland financial institutions allowed to issue RMB denominated bonds in HK subject to approval 2009 RMB cross-border trade settlement 2010 Foreign companies can issue RMB- bonds in HK 2011 RMB FDI and ODI 2012 Qianhai Shenzhen-Hong Kong Cooperation Zone will allow HK banks to lend directly to mainland firms

Hong Kong RMB deposit growth surged early but has since levelled off as RMB trade settlement stabilized

RMB Deposits and Trade Settlement in Hong Kong SAR

(In billions of RMB) 700 600 RMB deposits in Hong Kong (left scale) 500 RMB trade settlement through Hong Kong banks 400 300 200 100 0 2010 Sources: CEIC; and HKMA.

2011 2012 300 250 200 150 100 50 0

The share of trade settlement in RMB has levelled off as volatility makes it riskier to denominate trade in RMB 500 400 300 200 100 0

China: RMB Cross-border Settlement for Trade

(RMB bn) 800 700 600 Service trade Goods trade (%) Share of trade settled in RMB in total trade (right axis) 16 14 12 4 2 0 10 8 6

|

2010

|

2011

|

2012

|

Banks have issues CDs that have absorbed deposits flows as they increase RMB lending (68 bn, end-Sept)

RMB Deposit and Certificates of Deposit in Hong Kong

(In billions of RMB) 600 RMB CD RMB deposits 600 400 400 200 200 0 04 05 06 07 08 09 10 11 12 0

Issuance of RMB Bonds surges while banks issue RMB CDs to raise funds for RMB lending

CNH Bond Outstanding Breakdown

(In billions of RMB) 250

November o/s: RMB 247 bn

200 250 200 150 100 Bonds/Notes 150 100 50 0 07 08 09 10 11 12 50 0

RMB denominated FDI to the mainland has surged

China: RMB Cross-border Settlement for Investment

(In billions of RMB) 25 Outward direct investment Foreign direct investment 20 25 20 15 10 5 15 10 5 0 Jan.12

Feb.12 Mar.12 Apr.12 May.12 Jun.12

Jul.12

Aug.12 Sep.12

0

The creation of the RMB QFII also boosted RMB portfolio flows from Hong Kong to the Mainland

China: RMB Qualified Foreign Institutional Investors

(RMB billions) 25 20 RQFII: monthly approval (left axis) RQFII: cumulative approvals since inception 15 10 5 0 Dec 2011 Jan 2012 Feb Mar Apr May Jun Jul Aug Sep 45 40 35 30 25 20 15 10 5 0

Measures supported RMB internationalization

Sources of RMB funds Uses of RMB funds 2004 Deposits, exchange – individuals, designated merchants 2004 Exchange, remittance 2007 RMB bonds 2009 RMB trade settlement 2010 RMB loans to corporates 2010 RMB CDs, FI accounts 2010 –2012 trade settlement expanded 2010 Pilot scheme to invest in Mainland interbank bond market 2011 CN’s ODI settled in RMB 2011 Stock listing in RMB 2012 RMB LTD ratio relaxed 2012 RMB liquidity facility at HKMA 2012 RMB deposits for non-residents 2011 RMB FDI 2011 RMB Loans relating to CN’s ODI 2012 RMB QFII – A-share ETF 2012 Qianhai plan allowing HK banks to lend from HK to CH

Volatility in CNH-CNY differential reflect incomplete financial integration in offshore and onshore market

RMB Exchange Rates: Onshore vs. Offshore

(RMB/USD) 6,90 6,80 6,70 USD/CNH-USD/CNY (right axis) USD/CNY USD/CNH 6,60 6,50 6,40 6,30 6,20 06

|

09 2010 12

|

03 06 2011 09

|

12 03 2012 06 09

|

(pips) 1500 1000 500 0 -500 -1000 -1500

Volatility in CNH-CNY differential reflect incomplete financial integration in offshore and onshore market ($ bn) 80

Short term capital inflows to China and the CNY-CNH basis

(pips) 1200 Short-term capital inflow 1/ CNY-CNH (left scale) 1000 60 800 40 20 0 600 400 200 0 -20 -200 -400 -40 -600 10.8 10.10 10.12 11.2 11.4 11.6 11.8 11.10 11.12 12.2 12.4 12.6 12.8 12.10

1/ change in foreign exchange purchase position minus trade balance and net direct investment inflow.

Challenges for RMB internationalization remain • RMB internationalization has depended on measures expanding cross border flows of RMB • Demand for offshore RMB financial products healthy, but • RMB liquidity in Hong Kong is tightening as both RMB deposits and trade settlement volumes have leveled off • Redenomination of trade from dollars to RMB is slowed by the difficulty hedging RMB interest rate risk • RMB internationalization must be a market driven process, the supporting infrastructure need further development