The People’s Bank of China’s requirement on onshore RMB deposits by offshore financial institutions will have little impact on onshore liquidity and limited impact on offshore liquidity, but could lead to more capital outflows, says a research report by ANZ.
The Chinese central bank will apply the general reserve requirement rule on onshore RMB deposits by offshore financial institutions, effective on Monday, 25 January.
The market has interpreted the move as a way to target offshore speculative attacks on the RMB, but the real intention of the measure is to mitigate regulatory arbitrage for the long term, says the bank.
ANZ estimates that the size of onshore deposits by offshore financial institutions was RMB920 billion.
As a result, the required reserve is estimated to be a small amount of RMB161 billion, roughly 0.1% of China’s M2, which measures the size of money supply including cash, checking deposits and savings deposits, money market mutual funds and other time deposits.
For offshore liquidity, the withholding amount of RMB161 billion is no more than 10% of RMB deposits offshore, and has not been part of offshore liquidity at the outset.
But this rule could discourage offshore financial institutions and clearing banks to send their RMB onshore, thus potentially reducing capital inflow at a time the authorities should encourage.
In the past, offshore financial institutions, especially those Chinese clearing banks, can arbitrage the exchange rate difference between offshore RMB (CNH) and onshore RMB (CNY), helping narrow the gap between onshore and offshore.
The new rule runs the risk of allowing the exchange rate differential to persist, which strengthens the one-way depreciation expectation led by the CNH market. This in turn will encourage more capital outflow from onshore.
It seems that the Chinese central bank still wants to use administrative measures to regulate capital outflow and directly intervene via Chinese banks to stabilize offshore RMB exchange rate.
It is critical for the authorities to re-establish credibility and prevent the currency from weakening from certain threshold level, warns the bank.
In addition, China’s capital market could be opened wider for foreign participation so as to encourage capital inflow. Such a policy could lead to two-way capital flows, which will help dissipate RMB’s one-way depreciation expectation.