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Onshore Versus Offshore RMB

TOM BUTCHER: Can you tell me about the differences between onshore and offshore Chinese renminbi?

FRAN RODILOSSO: Let’s start at the top. China has one currency: the renminbi. You’ll hear it called the RMB or sometimes the yuan, which is actually a currency unit, i.e., the unit of RMB. The RMB trades both onshore and offshore, and there are, as you suggested, differences between those markets. You will see the ticker CNY is typically used to denote the onshore Chinese currency and the ticker CNH is usually used to describe the offshore Chinese currency, the offshore RMB. The "H" originally stood for Hong Kong because that was the first offshore market where China allowed free trading of its currency. Today CNH trades in a number of major financial centers.

The main difference between the onshore and offshore trading of the RMB is that onshore RMB trading is highly restricted. For the most part, only certain onshore entities are allowed to engage in foreign exchange transactions on the onshore RMB. Also, the exchange rate itself is a managed float. In fact, it's very highly controlled by China's central bank, the People's Bank of China. As such the RMB onshore is set each morning; a fixing is set by the central bank. Then it's allowed to trade only within a band. CNH, or the offshore RMB, also has a morning fixing but it is allowed to trade in any variation from its fixing.

BUTCHER: Can the onshore and offshore values diverge?

RODILOSSO: They can and do diverge but there are limits to how far they diverge over time. The same Chinese onshore entities that can access foreign exchange markets with the onshore currency, and particularly for current account and trade purposes, can also do it with the offshore currency. For instance, a Chinese oil importer. For those types of transactions it is very large amounts of currency that are exchanged and those importers have the choice of which market to go to. Consequently, over the medium term and certainly the long term, this dynamic will bring the two rates very closely in line with each other. It’s a “no arbitrage” rule in a way.

However, over very short periods of time, you’ve seen that CNH-CNY basis widen quite a lot, particularly when the onshore rate itself is very volatile. This has been the case in late 2015 and early 2016, when the market saw China’s central bank actively devalue the currency in a small portion and anticipated that China’s central bank may need to devalue further over time.

BUTCHER: Thank you. Who is not allowed to use which currency?

RODILOSSO: That's a very good way of putting it. There are only limited ways in which foreigners can use or access CNY. Slowly, China has been liberalizing various parts of its economy, including the currency. That's why the offshore currency exists. Now, however, foreign investors in onshore financial markets can access CNY in very small amounts via a quota system, either directly through the QFII (Qualified Foreign Institutional Investor) system, a program that selectively allows global institutional investors to invest in China’s RMB-denominated capital markets, or through the RQFII (RMB Qualified Foreign Institutional Investor) system, which is another way for foreign investors to participate in mainland China’s securities markets. RQFII allows Hong Kong subsidiaries of qualified mainland asset management firms to channel RMB raised in Hong Kong to invest in mainland China.

The vast majority of CNY transactions have to be documented by trade transactions, etc. It’s still a very, very closed market onshore. CNH is open to everyone. The offshore RMB is used for both trade and financial transactions. There's an offshore bond market; you’ve probably heard of the dim sum market, which refers to it. It's actually very small relative to China's onshore market. In fact, through the QFII and, more recently, RQFII programs, foreign investors are gaining greater access to China's onshore bond market.

BUTCHER: Thank you. Moving on to the IMF (International Monetary Fund), now that the renminbi is included in the IMF's Special Drawing Right (SDR) basket, where do you see its future heading?

RODILOSSO: I think the IMF's decision to include the RMB in its SDR basket is largely symbolic at this point. It hasn't had a major technical impact and certainly hasn’t led to strength in the currency, which has been weakening. It’s an endorsement of the liberalization steps that China has been taking. While there is a long way to go, China has considerable interest in making the RMB an international currency and a much bigger part of global trade. It has already become something of a reserve currency but it's still a very, very small percentage of global central bank reserves.

BUTCHER: Should we expect one type of renminbi—onshore or offshore—to disappear over time?

RODILOSSO: All of the world's major currencies, e.g., the dollar, the euro, the yen, have onshore and offshore markets but those currencies are fully fungible across those markets. There's full convertibility everywhere. China also has an onshore and offshore market but different rules apply. I believe that the market, as well as China, hopes that over time China will continue to ease restrictions on the onshore market and ultimately have there be no difference between the onshore RMB and the offshore RMB, i.e., one exchange rate for the currency.

BUTCHER: Totally fungible.


BUTCHER: Fran, thank you very much.

RODILOSSO: My pleasure, Tom.

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