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The Forex Flow

The Forex Flow
 
     
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The key geopolitical story of the last decade has been China’s emergence as the world’s second economic power. By any relevant metric, the weight of the Chinese economy has skyrocketed, even as Western economies have begun a gradual decline. And yet, the Chinese currency has remained a bit player in worldwide foreign exchange (FX) markets.

Behind the Times

One tenet of international finance is that no country can simultaneously have an independent interest rate policy, a fixed exchange rate and free flow of capital. By choosing the first and second pillars, China has rejected the third, enabling the country to maintain a policy of slow but steady appreciation since the 2005 one-off revaluation.
China has implemented RMB trading controls by making it a non-deliverable currency; in other words, by restricting onshore market RMB access to importers and exporters, as well as allowing a strictly controlled set of capital account flows, mostly in the form of FDI. Portfolio flows are severely restricted, and access to the RMB onshore forward curve is limited to domestic corporations. This means that domestic RMB trading is mostly driven by trade flows. Given the chronic trade surpluses, authorities need to sell RMB on this market continuously in order to limit appreciation pressures.

An Increasing Role

However, the currency’s low profile is increasingly unsustainable; in the coming years, the RMB will play an important role in FX markets both as a means of international exchange and a store of value.
Still there are concerns. Chinese authorities worry about both macroeconomic overheating and the excessive weight of investment – at the expense of consumption – in the Chinese economy. In addition, developing countries continue to amass huge FX reserves, as first-world currencies are looking ever more unstable. If and when the country loosens its currency regulations, demand for the RMB should intensify. Last year’s move to make offshore RMB in Hong Kong (CNH) a deliverable currency is one sign that China is moving in this direction.

Three Markets for Trade

Chinese currency trades in three main markets: the onshore market, the unofficial non-deliverable forward market (NDF) and Hong Kong’s relatively newer official offshore market. As mentioned previously, authorities keep the RMB onshore market isolated from the offshore markets by restricting it to importers, exporters and FDI.
This meant that until recently, NDF was the only option open to offshore participants seeking to manage their Chinese currency risk. As of 2010 however, Hong Kong’s new deliverable offshore market allows for greater freedom of exchange. The only officially sanctioned and regulated offshore market for Chinese currency, NDF sees no price-level intervention; however, transfers to the onshore market are heavily regulated.
Despite this, as the trading volumes increase and regulations are relaxed, managing RMB/US$ exposure will become as important as the EUR/US$ or EUR/GBP rates are today.

Utilising an FX brokerage that provides both advisory and trading services in Chinese currency will become increasingly critical to businesses. Ebury Partners offers both, as well as sophisticated analysis of Chinese economic and financial trends and the ability to execute trades for our customers in both the NDF and CNH markets.

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