Event

(1) The PBoC revised regulations on June 21, allowing foreign institutions to invest in Negotiable Certificate of Deposit (NCDs) circulated in China’s interbank market.

(2) The Monetary Authority of Singapore (MAS) announced on June 22 that it will include RMB investments as part of its official foreign reserves from this month onwards.

Comments

The expansion of the access to interbank NCDs may have limited short-term impact, but it represents an important step towards RMB internationalization. The PBoC opened the interbank market to foreign central banks last July and refined the access procedures in April. It also opened the market to non-official foreign institutions in February, covering foreign commercial banks, insurers, securities companies and fund managers. The current move further allows them to invest in interbank NCDs, an important funding source for banks and money market instrument for investors. As of May 2016, the volume of NCDs outstanding was Rmb4.6trn. It may take time for foreign investors to adapt to the access procedures and China’s regulatory framework as well as RMB volatility. Their participation may increase at a slow pace in the beginning. However, the action marks China’s continued efforts to open its financial markets and increase the investability of the RMB.

The MAS’ move shows that the RMB’s SDR inclusion is not just symbolic. The MAS held US$244.5bn in FX reserves as of May 2016, the 11th largest reserve holder globally. If it were to raise the RMB’s share in reserves to 5%, this would correspond to a reallocation of US$12.2bn or Rmb80.4bn to RMB assets. Back in January 2014, the Central Bank of Nigeria announced it would increase the RMB holding in the nation’s foreign exchange reserves from 2% to 7%. IMF data shows $94 billion of official assets were already held in RMB at end of 2014, accounting for 1.1% of global FX reserves. The increase of RMB holdings is likely to continue as more central banks set official targets for the RMB in their reserve pools, especially after the new SDR basket comes into effect.

RMB internationalization efforts lend support to the RMB’s exchange rate. Despite the recent exchange rate volatility, the developments show that RMB internationalization is still under way. As it plays an increasingly important role, the foreign demand for the RMB and RMB assets tends to grow. We estimated that the RMB has the potential to rise to 3.7% in global FX reserves under the current conditions, corresponding to an inflow of Rmb2.7trn to China. In the meantime, we see small room for Fed rate hikes this year and hence limited upside of the USD index. And China’s domestic economic environment appears more stable and favorable compared with that of the G3. In short, economic fundamentals do not seem to support a large depreciation of the RMB.