Motivation differentiates eurodollar and CNH markets

The key difference between the creation of today’s CNH market and the eurodollar market five decades ago is the motivation behind it, says Claudio Piron, head of Asia ex-Japan fixed income and FX strategy for Bank of America-Merrill-Lynch.

He was speaking to an audience of investors and fund managers at the JW Marriott Hotel in Hong Kong this week where the bank hosted a day-long event to frame an understanding of the long road to RMB internationalisation.

“The eurodollar market created in London in the 1960s was a market solution to get around some of the reserve requirement and liquidity restrictions in the US market,” notes Piron. “The CNH market in a way is a government-inspired solution to deal with issues of liquidity for China and to internationalise.

“I think authorities in China have become increasingly aware, crisis after crisis, that more needs to be done to get away from dollar dependency. So I do think there’s a clear motivation.”

It was as far back as March 2009 that China’s central bank governor Zhou Xiaochuan floated the idea of replacing the US dollar as the international reserve currency in favour of a system linked to the International Monetary Fund’s (IMF) Special Drawing Rights (SDR).

“China’s greater role in the IMF and the creation of an offshore bond market would help to establish the RMB within the SDR, although this is a long way down the road,” says Piron.

There’s obvious asymmetry in the fact that China doesn’t want excess liquidity to pour into the country, yet there is excess global demand to gain exposure to China, “which at this present stage is clearly the biggest story of the millennium as an investment opportunity”, says Piron.

He notes that creating an offshore currency market has the dual effect of reducing not just the costs of sterilisation but also potentially foreign exchange risk, given that China’s huge FX reserves are predominantly in US dollars.

Beijing noticeably slowed its RMB internationalisation process during 2009 in the fallout of the global financial meltdown. But since July 2010 the CNH market has seen Rmb360 billion accumulate in cross-border trade settlements, primarily driven by the flow of importers settling in CNH.

“Once the crisis seemed to be behind us, we have seen an acceleration of this process and I think that will continue to build as we go forward,” adds Piron.

In its drive to internationalise the currency, the People’s Bank of China (PBoC) has Rmb803.5 billion in bilateral swap agreements in place with central banks around the world.

But Piron says it is China’s regional drive to develop its offshore currency market that is of greater focus right now, noting that BOC HK had also become a clearing bank for the creation of a renminbi equivalent in Taiwan. “So this will develop and the regional purpose of this development will be key,” he says.