ONE YEAR ON: MAJOR MILESTONES ACHIEVED AND OPPORTUNITIES AHEAD

CNH ket Monitor 1 JULY ONE YEAR ON: MAJOR MILESTONES ACHIEVED AND OPPORTUNITIES AHEAD This week Hong Kong celebrates the first anniversary of the offshore RMB business centre. The milestones achieved include: a six-fold rise in RMB deposits, commonly known as CNH, from RMB9bn in e to RMB9bn in ; RMB8bn in debts issued in the first half of, thus securing the city s pioneering role in developing RMB offshore products; and the launch of the first offshore RMB-denominated Initial Public Offering. Looking ahead, Hong Kong will continue to strengthen its role as a leading offshore RMB centre, driven not only by the economic imperatives and political will of the Hong Kong and Chinese authorities but also by China s macroeconomic policy. With rising inflation and robust economic activities, China s monetary policy will continue its tightening bias. We expect the spread between onshore and offshore interest rates to widen further and the RMB spot rate will continue to appreciate, offering a strong incentive to long the offshore RMB and raise RMB debts offshore. FEATURE CHART: THE SIX-FOLD RISE OF RMB DEPOSITS IN HONG KONG Hong Kong - RMB Deposits 3 8 Deposit, RMBbn Trade settlement amount, RMBbn RMB as % of Total Deposits (RHS) 9 8 7 3 1 Sources: CEIC, ANZ Research

HONG KONG S POOL OF OFFSHORE RMB CONTINUES TO GROW Since the signing of a 19 y memorandum by the Hong Kong Monetary Authority (HKMA) and the People s Bank of China (PBoC), Hong Kong s RMB deposits have risen rapidly to reach RMB9bn in, compared with RMB89.7bn in e, resulting in an average monthly growth rate of 1%. The take-off of RMB cross-border trade settlements has been a major driver of CHN growth. In the first five months of, accumulated RMB remittances for cross-border trade settlement hit a total of RMB98bn, equivalent to about % of Hong Kong s total trade with the Mainland in the same period. Should this trend continue, and provided that the authorities do not rein in the development, we expect CNH deposits to reach around RMB1trn by the end of. NEW PRODUCTS FLOURISH In the past 1 months, we have seen a slew of RMB-denominated products and market developments (see Appendix A for major milestones). The locally-dubbed dim sum bonds continue to be the star performer of the offshore platform. Offshore CNH debt issuances jumped to RMB8bn in the first six months of, from RMB1.bn in the previous 1 months; the six-month figure consists of RMBdenominated bond issuances of around RMBbn with RMB-denominated certificates of deposits (CD) making up the remaining RMBbn. While these debts offer a coupon at around -3% on average, without adjusting for rating and tenor, some issuers have been willing to offer a coupon as high as 7%. In il, the Huixian real estate investment trust (REIT) became the first RMB-denominated IPO outside of China and its smooth listing on the Hong Kong Exchange was deemed a success. This year we expect to see more IPOs in the pipeline despite the global economic uncertainties which continue to weigh on market sentiment. Recently, the global giant of futures and options bourses the CME group announced it will launch a new RMB foreign exchange futures contract. Similar to the NDF, contracts will be quoted in USD/RMB and referenced to the daily RMB fixing. The contracts will come in standard (USD,) size, and an E-micro (USD,) size aimed at retail investors. The new futures contracts are likely to increase the competition in the offshore forward/futures market. Meanwhile, the launch of such a product would give rise to new arbitrage opportunities between the NDF, CNH forward and the CME Group s RMB futures. In e, the Hong Kong Treasury kets Association (TMA) launched an offshore spot USD/CNH fixing. The fixing is calculated by averaging the middle quotes after excluding the two highest and two lowest quotes from the rates provided by contributing banks. This will provide a benchmark reference and will enhance the development of new CNH products. 3 8 Hong Kong - RMB Deposits Deposit, RMBbn Trade settlement amount, RMBbn RMB as % of Total Deposits (RHS) 9 8 7 3 1 CNH Bond Coupon Curve 8 7 3 1 1 3 7 8 9 Issuance Weighted Average Sources: Bloomberg, ANZ Research

THE ONSHORE AND OFFSHORE RATE SPREAD CONTINUES TO WIDEN Since the HKMA launched new measures last ember to ensure market liquidity, the spread between the CNY (onshore) and CNH (offshore) exchange rate has converged in. However, the difference between onshore and offshore forwards persists as China s capital control is still effective. Interestingly, the spread between the offshore 1-year NDF and the onshore 1-year CNY forward reversed in. Prior to this, the NDF usually traded on the strong side of the onshore forward. Meanwhile, the CNH forward rate has been consistently priced for a slower appreciation trend than is the NDF and the onshore forward. 3. 3... 1. 1.. Onshore and Offshore RMB Deposit Rate (% p.a). 7 8 Hong Kong RMB 3m Deposit Rate China RMB 3m Deposit Rate.8.8.7.7..... RMB Onshore and Offshore Exchange Rates Oct CNY Spot Jan CNH Spot Sources: CEIC, Bloomberg, ANZ Research As part of China s monetary tightening policy, the PBoC has already raised policy interest rates three times this year, widening the spread between the onshore and offshore rates. At the time of writing, China s benchmark one-year lending rate is.%, while the one-year deposit rate is 3.%. Meanwhile, the offshore RMB market remains a low-rate environment. The spread between the three-month deposit rate in the onshore and offshore markets widened in e to around 3bps. Hong Kong is becoming increasing popular as a fund raising and lending platform with its banks claims on Chinese entities having increased to HKD191bn in from HKD77bn in e......38.3.3.3.3 1 RMB Onshore and Offshore Forwards 1 9 13 7 8 1y NDF 1y CNY Forward 1y CNH Forward, 1,8 1, 1, 1, 1, 8 Hong Kong - Banks' Claims on Customers in Mainland China Oct Jan Oct Non-HKD Claims, HKDbn HKD Claims, bn % of All External Claims (RHS) Jan 3 1 Sources: CEIC, Bloomberg, ANZ Research REPATRIATION REMAINS A MAJOR CONCERN

A major challenge for the offshore RMB market is that RMB funds raised offshore are still difficult to repatriate to the Mainland. In response to growing concerns, the PBoC allowed eight foreign banks to join a pilot program in ch that enabled the investment of their offshore RMB holdings in the onshore interbank bond market, thus broadening the repatriation channels. Furthermore, the PBoC issued formal rules in e to allow RMB-denominated foreign direct investment (FDI). The rules stipulate that RMBdenominated FDI will not be allowed in certain sectors and will require a case-by-case review by PBoC headquarters. Nonetheless, the issuance of rules in itself indicates the authority s willingness to channel some RMB funds back onshore under a managed system and on a gradual basis. Until repatriation can be conducted more freely, which is unlikely in the immediate future, the large onshore and offshore yield difference will continue due to the limited use of the RMB in the offshore market. OUTLOOK FOR THE CNH MARKET The latest macroeconomic developments in China will continue to favour the expansion of offshore RMB markets. As China s GDP grew at a strong rate of 9.% in Q, the risk of a hard landing was overblown. Therefore, the number one concern remains inflation. With e s CPI reporting a.% y/y increase and with inflationary pressures still strong, it is premature for the PBoC to halt its monetary tightening. We expect the interest rate tool will again be used to address the negative real interest rate problem, while a stronger currency will help tame imported inflation. For the second half of, we expect one more policy rate hike in Q3, and maintain our forecast of a -% appreciation of the RMB exchange rate for the year as a whole. This policy stance will continue to benefit the CNH market. Lower borrowing costs will provide Chinese firms the motivation to use Hong Kong as a fund raising centre. On the demand side, the faster appreciation of the RMB will attract more investors to stock up on RMB-denominated assets. As such, CNH deposits, offshore RMB bonds and other RMB-denominated instruments will continue to be popular in the second half of. Even though China will continue to establish SWAP agreements with other countries (see Appendix B), Hong Kong will continue to benefit from its close proximity with the Mainland and its first-mover advantage as the RMB continues to internationalise. We expect that once RMB deposits reach one trillion CNY, the Hong Kong RMB offshore market will be sizable and more liquid, allowing secondary market activities to flourish and more CNH-denominated products to emerge. Hong Kong as China s international financial centre will only strengthen. China - GDP Growth China - CPI Inflation 18 1 1 1 8 7 8 7 3 1-1 - -3 8 7 3 - - -3 - y/y q/q, saar Headline, y/y Pork Prices, y/y (RHS)

8 - - - 8 China - Trade Developments 3 - - -3 China - Exchange Rate and Interest Rate 8. Forecast 8. 7. 7... 7 8 1 8. 7. 7....... 3. Trade Balance, $bn (RHS) Exports, y/y Imports, y/y USDCNY Spot PBoC 1-year Lending Rate (RHS) Sources: CEIC, Bloomberg, ANZ Research APPENDIX A MAJOR MILESTONES IN RMB INTERNATIONALISATION e China expands the RMB trade settlement scheme to provinces and cities. y The HKMA and PBoC sign a memorandum of co-operation on RMB business ust A pilot scheme is announced for the RMB clearing bank and other eligible institutions outside mainland China to invest in its interbank bond market. ember RMB sovereign bonds are issued through the Central Moneymarkets Unit (CMU). ember The HKMA and PBoC refine arrangement for conversions of RMB for cross-border trade settlement transactions. January The PBoC announces a pilot program, allowing qualified enterprises in mainland China to conduct and settle overseas direct investment in RMB, and banks in Hong Kong will be able to provide RMB funds to facilitate such transactions. ch China approves eight foreign banks to invest in its interbank bond market, allowing offshore banks to invest their CNY positions bank onshore. The HKMA launches the Renminbi Fiduciary Account Service, which is an arrangement to help Participating Banks to better manage their credit exposure to the Clearing Bank for RMB business in Hong Kong. il The first RMB-denominated IPO outside of China, Hui Xian real estate investment trust (REIT), is successfully listed on the Hong Kong Stock Exchange. e The Financial Supervisory Commission announces that it will allow Taiwanese offshore banking units (OBU) to conduct RMB-denominated business. Sources: HKMA, ANZ Research The Hong Kong Treasury kets Association (TMA) launches an offshore spot USD/CNH fixing. The fixing is calculated by averaging the middle quotes after excluding the highest two quotes and lowest two quotes from the rates provided by contributing banks. The PBoC announces a set of regulations regarding RMB-denominated FDI.

APPENDIX B PBOC SWAP AGREEMENTS WITH FOREIGN CENTRAL BANKS Date Country Size of Swap Line (RMB bn) ember 8 South Korea 18 January Hong Kong ruary Malaysia 8 ch Indonesia ch Argentina 7 ch Belarus e Iceland 3. y Singapore 1 il New Zealand il Uzbekistan.7 Information as of e Sources: Press reports, ANZ Research NB: If you would like to be removed from this mailing list, please reply to this email and type 'unsubscribe' in the subject line. Li-Gang Liu Head of Greater China Economics ANZ Research ANZ Level 31, One Exchange Square, 8 Connaught Place, Central, Hong Kong Phone: +8 399 37 Emails: Ligang.liu@anz.com www.anz.com Raymond Yeung Senior Economist ANZ Research ANZ Level 31, One Exchange Square, 8 Connaught Place, Central, Hong Kong Phone: +8 399 8 Emails: Raymond.Yeung@anz.com www.anz.com Louis Lam Analyst, Greater China Economics ANZ Research ANZ Level 31, One Exchange Square, 8 Connaught Place, Central, Hong Kong Phone: +8 83 7 Emails: Louis.Lam@anz.com www.anz.com is represented in various countries including

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