Effects of CNH Exchange Rate on Offshore RMB Interest Rate

Bank of China (Hong Kong) | 26 Mar 2015

Effects of CNH Exchange Rate on Offshore RMB Interest Rate

Since November 2014, the exchange rate of offshore RMB to USD (CNH exchange rate) has depreciated while choppy CNH HIBOR led to a significant increase in capital cost. This article will discuss whether this phase of RMB interest rate fluctuation has a causal relationship with the depreciation of RMB and the dynamics of such relationship.

Effects of different sources of funds in offshore markets on RMB interest rates

Interest rate is the cost paid by those who demand capital. Hence, in order to answer the first question, we have to understand the channels for obtaining RMB capital in the offshore market and their impact on interest rates.

Unlike onshore parties who gain liquidity mainly from repurchase agreement (Repo) and the interbank market, parties in the offshore market gained RMB liquidity from the following three ways, namely, CNH swaps, interbank lending and CNH CCS. These three channels have different impacts on offshore RMB interest rates.

CNH swap refers to the use of foreign currency (mainly USD) to swap with RMB, which is similar to using USD as collateral for RMB loans. Currently, RMB swaps average approximately USD 20 billion in daily trading volume, much higher than that of interbank lending (on average USD 5-8 billion per day), and are the main channel for obtaining capital in the offshore RMB market. The “CNH Implied Yield” from CNH swap trading has also become the unofficial benchmark rate in the offshore RMB market.

Interbank lending requires the lender to pre-approve a credit line to the borrower in advance. Since such lending is essentially unsecured loans, there are certain requirements for participating institutions, limiting the capital pool available for interbank lending. Therefore, interbank lending is not as active as CNH swaps. One should also note that the quotations of offshore interbank lending are calculated mainly using CNH Implied Yields of the corresponding tenor. Therefore, price changes in offshore RMB capital will first be reflected in CNH Implied Yield and then be transmitted to interbank lending rates. As shown in the diagram below, CNH Implied Yield and CNH HIBOR Fixing are closely correlated, but the latter one is a bit less choppy as it is merely a daily fixing rate and does not represent actual market transactions.