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Playing the Long Game in China

Despite a bearish outlook on China and its currency right now, panellists at Profit & Loss Shanghai claimed
that in the long-term, the fundamentals are in place for RMB development.

While China’s economy continues to enjoy growth rates
that most fully developed economies could only dream
of, the slowing of this growth rate has led to negative
sentiment about China from some international investors.

“The perception outside of China about China’s economic rebalancing
is very critical right now,” said Ivan Shi, a director at
Z-Ben Advisors. “Talking to our clients, a lot of asset managers
say that it is difficult to sell the Chinese story to their investors,
especially in the regional market, and I think that this is driven
in part by the perception of China in the mainstream media. The Chinese economy and markets have a lot of challenges,
no doubt, but I think that while a lot of the reforms being
implemented at the moment will have a lot of short-term
downward pressure on economic growth, the long-term
implications for the economy are not very well understood.”

Similarly, Chris Chen, a representative at PNC Bank Shanghai
Representative Office, made the case that while he expects to
see RMB depreciation, especially in the face of the current
USD strength, he envisions this as being a short-term trend.

“Yes, the RMB is experiencing some volatility and some
weakness, but the infrastructure is there for the currency to
develop and grow. It’s important to focus on the long-term
development of RMB and as a whole I’m fairly bullish on this,”
he said.

Discussing the future of the RMB, Shengju Zhang, general
manager of the research department at the China Foreign
Exchange Trade System (CFETS), said that the end-game for the
Chinese authorities is clearly to have a free floating currency.

“Just put yourself in the shoes of the central bank, to have to
manage the exchange rate is a huge burden for them,” he
observed. But he added that to achieve this goal the Chinese
authorities will move slowly and in incremental steps.

Shi echoed this sentiment, noting that for many international
financial services firms, the biggest challenge is accessing the
Chinese market. In this regard, he claimed that the inclusion of
the RMB into the International Monetary Fund’s (IMD) Special
Drawing Rights (SDR) basket is a significant step.

“RMB SDR inclusion has tremendous implications. It is a very
big milestone for the internationalisation of RMB and how this
relates to the global asset managers is that RMB
internationalsation is more about the opening of the capital
accounts in China and the opening of the financial industry in
China to global participation,” he said.

Explaining the different investment programmes that the
Chinese authorities have launched for outside investment firms
over the past five years, Shi highlighted the progress that has
been made towards a more liberalised capital account in China.

“There has been a gradual liberalisation process of the capital
account, which has now made it much easier for global asset
managers to create market products in China and put China
exposure into emerging market or global portfolios,” he said.

However, this liberalisation is likely to remain at a fairly
steady pace in some areas because, as Zhang noted, banks in
China are still challenged by the fact that the onshore FX
market remains relatively small in size.

“This means if there’s an external shock the market
sometimes can’t absorb that, which leads to the central bank
intervening to maintain an orderly market. Even though the
current accounts are still not convertible, the capital flows can
fluctuate quite rapidly,” he says.

The idea of a free-floating currency implies that there must
be a convergence of the offshore and onshore Chinese
currency markets.
“But what is the journey to get to this point? That’s the
million dollar question,” said Chen.

He continued: “The infrastructure for RMB as a payments
currency, a trade currency, an investment currency, an asset
currency or a reserve currency is there; it’s built. I think that right
now the next steps could be to improve on that infrastructure. If you look at onshore hedging, it can be done. You can do
cross-border trade payments via onshore with RMB without any
problems, but I think it is the inner workings of how certain
things are done onshore compared to offshore that are not as
easy or as transparent as they could be. That’s what could be
improved upon from an onshore perspective to get us to the
point of onshore and offshore convergence.”

Yun Zou, deputy managing director, head of fixed income and
currencies trading, China, at Deutsche Bank, said that in order
to move to a free floating currency, China needs to open up its
capital markets.

“The way that we go to the free floating currency is we need the
capital markets, FX plus fixed income, to be more open to
everyone, we need more players in these markets and specifically
more diversified players. If we look at the onshore market, the
majority of FX transactions are done by corporates hedging, but if
you look at the CNH market, there is a lot more speculators. So for the development of onshore trading we need
different types of firms trading the currency and we need 24-
hour trading for CNY.

“Secondly, CNY needs to be not only an asset for global
investors, but also a funding currency. If we can get to the point
where firms can invest into China, if they have a need to raise
funding and can then hedge however they want, if they have an
operational demand, then I think that the CNY will become a
very international currency,” he said.

Galen Stops

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