China’s currency

The yuan is flowing beyond China’s borders—and back again






THE helicopter buzzed to and fro, hour after hour, high above Hong Kong’s shining harbour and glistening skyscrapers, a bright red advertising banner trailing behind. What unmissable opportunity was it selling? Government bonds, that’s what, yielding as little as 0.6%.

The bonds were issued on August 17th by China’s Ministry of Finance in its own currency, the yuan. That would not normally be a banner-waving event. But what made this sale notable was its size—20 billion yuan ($3.1 billion)—and its buyers: offshore investors in Hong Kong. It represents by far the biggest issue of “dim sum” bonds, securities denominated in the currency of mainland China, but sold in Hong Kong, where people like to eat dumplings, pork buns and other tasty morsels known as dim sum. It therefore marks another step in the globalisation of the redback.

The first such bond was sold by China Development Bank in 2007. The bank has since been followed by more than 80 other issuers, including the World Bank, a Russian bank, McDonald’s, Volkswagen and a casino operator.

Despite these headline-grabbing offerings, the dim-sum market has remained true to its name: “delicious but limited”, as Tony Wang of Bank of China put it at a conference organised by the Centre for Financial Regulation and Economic Development (CFRED). Bond sales have remained bite-sized and quick to digest, with a typical maturity of two or three years. By the end of June, there were 4.7 yuan in Hong Kong deposits for every one yuan of dim-sum debt (valued at its issue price). That is why the finance ministry’s 20 billion yuan offering got everybody’s rotors beating.

No way home

This week’s bond issue will not be the government’s last, according to Li Keqiang, a Chinese vice-premier destined to succeed Wen Jiabao next year as prime minister. In a speech in Hong Kong on the day of the sale, he said that non-financial Chinese firms would be allowed to raise yuan offshore, a privilege previously reserved for mainland banks.

That will expand the menu somewhat. But the biggest deterrent to offshore borrowing is the difficulty of getting the money back onshore again. China’s government remains deeply ambivalent about the redback’s role in cross-border investment.

Chinese companies can now buy foreign ones with yuan; foreign firms can invest yuan raised offshore in their operations on the mainland. But both transactions are subject to government approval.

In the early days of dim-sum issuance, approval took only a month or two, a sign the government wanted the market to succeed. But because China’s authorities now worry that capital inflows will stoke an overheated economy, they have tightened up: one company that raised yuan in Hong Kong at the start of this year is still waiting to bring them across the border.

Mr Li’s speech may signal a softening of attitude. China already allows some “qualified” foreign investors to buy mainland securities, subject to a quota. These investments are settled in dollars. Now, Mr Li said, it will allow such investors to sink up to 20 billion of offshore yuan into China’s stockmarket too. That will give foreigners another reason to hold redbacks.

China’s government has no such ambivalence about the redback’s role in international trade. In 2009 it allowed firms in China’s most dynamic provinces to trade goods in yuan; this week Mr Li extended this right to the whole country. The currency was used to settle 600 billion yuan-worth of cross-border commerce in the second quarter of this year, up from less than 50 billion a year before (see chart 1). But that still represents only 7% of China’s total trade and 2% of the world’s.

Its role also remains lopsided. Of the trade settled in yuan in the first quarter of this year, 94% was foreign goods sold to China, not Chinese goods sold abroad. In other words, yuan flow out not in.

Yu Yongding, of the China Society of World Economics, argues that this outflow of redbacks is paradoxically tying China ever more tightly to the dollar. In the past, Chinese importers settled more of their trade in dollars. This dollar outflow relieved some of the upward pressure on the yuan’s exchange rate. Insofar as yuan settlement replaces this dollar outflow with a yuan outflow, it erodes one of China’s few channels for easing the pressure on its currency. To keep the yuan down, the central bank will end up adding more dollars to its stockpile, not fewer.

Foreigners will be keen to acquire yuan, and reluctant to part with it, for as long as they think it is artificially cheap. That perception was only reinforced by China’s external surplus of $69.6 billion in the second quarter, a big jump from the previous three months. That may have prompted China’s central bank to let the yuan rise to a rate of 6.4 redbacks to one green.

The government is also making diplomatic efforts on behalf of the redback. It is nudging countries such as Venezuela to pay in yuan. Indeed, in June yuan payments from the mainland to Hong Kong fell short of payments in the other direction, contributing to a conspicuous slowdown in offshore deposits. But that may reflect the Chinese regulator’s decision to tighten up on triangular trade transactions, in which Chinese importers paid yuan to an intermediary, who then paid the foreign supplier in dollars.

A pause in the breakneck growth of yuan deposits may be a relief to some. These deposits are not particularly profitable for Hong Kong banks, because they are struggling to find anyone to lend them to. In June, outstanding loans amounted to only 11 billion yuan, giving banks a yuan loan-to-deposit ratio of just 2%.

Hong Kong is keen to embrace its role as China’s offshore financial laboratory. But the experiment is not without side-effects. The helicopter buzzing back and forth across the skyline represents the financial centre’s more yuan-denominated future. But it was a relief when a rainstorm forced it to take a break. The Economist