The redback abroad

A fresh course

China’s offshore currency enjoys a promising end to a difficult year

Feb 9th 2013
Hong Kong

ON FEBRUARY 6th, a few days before the Chinese new year, banks in Taiwan offered something new to their customers: deposit accounts in China’s currency, the yuan. The banks were full of seasonal generosity, offering much better terms than depositors normally enjoy. At Bank SinoPac, customers without two yuan to rub together can open an interest-bearing account with only one.

Deposit-taking and trading in yuan was made possible by a clearing agreement, signed in August between China’s central bank and its counterpart in Taipei (which one mainland newspaper referred to as Taiwan’scentral bank”, the quotation marks reminding readers that China bitterly disputes Taiwan’s claims to sovereignty, in monetary matters or anything else). That deal is only the latest example of China’s unconventional efforts to promote the use of its currency beyond its borders, even as it maintains controls on capital flows across them.

These efforts began in earnest in July 2009 with a pilot scheme allowing a few Chinese firms to buy imports with yuan and sell exports for them. The yuan’s foreign career then took off in August 2010 when some Hong Kong banks were permitted to invest offshore yuan in the mainland’s higher-yielding bond market, thus giving them an incentive to hold the currency. Since then, the government has alternated between easing outflows of yuan from the mainland and easing inflows in the other direction. The yuan’s international flows have zigged and zagged.

So have its fortunes. In its early life the offshore yuan (known unofficially as the CNH) was more expensive than its onshore equivalent. The premium, which peaked at 2.6% in October 2010, reflected the eagerness of outsiders to hold an otherwise inaccessible asset that was expected to appreciate.

Borrowers took full advantage of this expectation, selling yuan-denominateddim sumbonds in Hong Kong for high prices and yields as low as 0.6%. But signs of trouble arrived in the autumn of 2011, as global financial turmoil prompted foreigners to dump emerging-market assets of all kinds.

The CNH premium turned into a sizeable discount. By the end of that year yuan deposits in Hong Kong began to fall (see chart). Then, in February 2012, the yuan stopped rising against the dollar, removing a big reason for offshore investors to hold the currency.

The market for dim-sum bonds changed from a seller’s to a buyer’s market. Issuance slowed and yields began to converge with similar bonds in the mainland. The world’s embrace of the yuan began to look provisional, not inevitable.

But the CNH can enter the Chinese new year with revived optimism. China’s currency has resumed its stately appreciation against the dollar, climbing by 2.5% since its July trough. Hong Kong’s yuan deposits have grown steadily since September (although they have yet to regain their 2011 peak) and the CNH is once again trading at a premium to its onshore cousin. And offshore investors have gobbled up $1.9 billion of yuan-denominated bonds so far in 2013, according to Dealogic, a data firm, up by 73% on a year earlier.

The question now is whether inflows or outflows will predominate in the year ahead—will the offshore yuan zig or zag? Taiwan’s entry onto the stage should hasten outflows. The country’s exporters enjoy the world’s biggest trade surplus with China. If they decide to settle much of their trade in China’s currency, their new deposit accounts in Taipei could fill up quickly.

However, inflows should also grow. China’s government is opening up new routes for offshore yuan to return to the mainland. Last month it finished dividing up a quota of 70 billion yuan ($11 billion), which qualified foreign firms will be able to invest in the mainland’s shares, exchange-traded funds and bonds. China’s securities regulator has said that another 200 billion yuan will be allotted soon.

A smaller but more interesting back channel also opened last month. Fifteen Hong Kong banks lent a total of 2 billion yuan, raised offshore, to businesses incorporated in Qianhai, a 15-square-kilometre (5.8-square-mile) district of Shenzhen just across the border from Hong Kong. At the moment the bay-side territory is little more than a building site. But it aspires to become a hub for professional services, offering waterfront living, low taxes and proximity to Hong Kong.

To help Qianhai fulfil that vision, its businesses can now borrow yuan from offshore banks. And they can do so at whatever interest rate the market will bear, even if it falls below the regulatory floor imposed on other loans in China. Since offshore rates are lower than onshore ones, the appeal is obvious.

Indeed, the appeal is potentially limitless. What is to stop every firm in China having a toehold in Qianhai so as to raise cheap funds for use elsewhere in the country?

During the pilot phase the lending will be subject to “stringent requirements, monitoring and reporting”, explains John Tan of Standard Chartered, one of the 15 banks involved. The loan amounts are subject to a quota. And the local and national governments are still thinking about how to ringfence the funds to prevent them escaping to other parts of the country.

Mr Tan is in any case confident Qianhai firms will want their money to stay where it is. There is plenty to keep the funds busy.

A newManhattan” must be conjured up, including offices, homes, schools, hospitals and landscapes. If it happens, Qianhai will be the first town that CNH built.

Op-Ed Contributor

China’s Hydro-Hegemony


Published: February 7, 2013

ASIA is the world’s most water-stressed continent, a situation compounded by China’s hydro-supremacy in the region. Beijing’s recent decision to build a slew of giant new dams on rivers flowing to other countries is thus set to roil riparian relations.
China — which already boasts more large dams than the rest of the world put together and has unveiled a mammoth $635-billion fresh investment in water infrastructure over the next decade — has emerged as the key obstacle to building institutionalized collaboration on shared water resources in Asia.
In contrast to the bilateral water treaties between many of its neighbors, China rejects the concept of a water-sharing arrangement or joint, rules-based management of common resources.
For example, in rejecting the 1997 United Nations convention that lays down rules on shared water resources, Beijing asserted its claim that an upstream power has the right to assert absolute territorial sovereignty over the waters on its side of the international boundary — or the right to divert as much water as it wishes for its needs, irrespective of the effects on a downriver state.

Today, by building megadams and reservoirs in its borderlands, China is working to re-engineer the flows of major rivers that are the lifeline of lower riparian states.

China is the source of transboundary riverflows to the largest number of countries in the world — from Russia, Kazakhstan and Kyrgyzstan to the states in the Indochina peninsula and Southern Asia. This pre-eminence resulted from its absorption of the ethnic-minority homelands that now make up 60 percent of its landmass and are the origin of all the international rivers flowing out of Chinese-held territory. No other country in the world comes close to the hydro-hegemony that China has established. 

Since the last decade, China’s dam building has been moving from dam-saturated internal rivers to international rivers. Most of the new megaprojects designated recently by China’s state council as priority ventures are concentrated in the country’s seismically active southwest, which is largely populated by ethnic minorities. Such dam building is triggering new ethnic tensions over displacement and submergence. 

The state council approved an array of new dams on the Salween, Brahmaputra and Mekong rivers, which originate on the Tibetan plateau and flow to South Asia and Southeast Asia. The unveiling of projects on the Brahmaputra evoked Indian diplomatic concern at a time when water has emerged as a new Chinese-Indian divide, while the Salween projects end the suspension of dam building on that river announced eight years ago.

The Salweenknown in Chinese as Nu Jiang, or the “Angry River” — is Asia’s last largely free-flowing river, running through deep, spectacular gorges and glaciated peaks on its way to Burma and Thailand. Its upstream basin is inhabited by at least a dozen different ethnic groups and rated as one of the world’s most biologically diverse regions, home to more than 5,000 plant species and nearly half of China’s animal species. No sooner had this stunning region, known as the Three Parallel Rivers, been added to the World Heritage List by Unesco in 2003 than Beijing unveiled plans for a cascade of dams near the area.

The international furor that followed led Prime Minister Wen Jiabao to suspend work. The reversal of that suspension, significantly, comes before Wen and President Hu Jintao step down as part of the country’s power transition. 

The third international river cited by the state council in its new project approvals has already been a major target of Chinese dam building. Chinese engineers have constructed six megadams on the Mekong, including the 4,200-megawatt Xiaowan, and a greater water appropriator, the 5,850-megawatt Nuozhadu, whose first generator began producing electricity last September. 

Asia needs institutionalized water cooperation because it awaits a future made hotter and drier by climate and environmental change and resource depletion. The continent’s water challenges have been exacerbated by growing consumption, unsustainable irrigation practices, rapid industrialization, pollution and geopolitical shifts.

Asia has morphed into the most likely flash point for water wars. Several countries are currently engaged in dam building on transnational rivers. The majority of these dams are being financed and built by Chinese state entities. Most Chinese-aided dam projects in Laos, Cambodia and Myanmar are designed to pump electricity into China’s southern electricity grid, with the lower riparians bearing the environmental and social costs.

But it is China’s dam-building spree at homereflected in the fact that it boasts half of the 50,000 large dams in the world — that carries the greatest international implications and obstructs the development of an Asian rules-based order.

China has made the control and manipulation of natural-river flows a fulcrum of its power and economic development. Although promoting multilateralism on the world stage, it has given the cold shoulder to multilateral cooperation among basin nations — as symbolized, for example, by the Mekong River Commission — and rebuffed efforts by states sharing its rivers to seek bilateral water-sharing arrangements.

Beijing already has significant financial, trade and political leverage over most of its neighbors. Now, by building an asymmetric control over cross-border flows, it is seeking to have its hand on Asia’s water tap.
Given China’s unique riparian position and role, it will not be possible to transform the Asian water competition into cooperation without Beijing playing a leadership role to develop a rules-based system.

Brahma Chellaney is the author of “Water: Asia’s New Battleground” and of the forthcoming book “Water, Peace, and War: Confronting the Global Water Crisis.”


February 5, 2013, 7:13 p.m. ET

Payback for a Downgrade?

The feds sue S&P but not Moody's for pre-crisis credit ratings.


Now, this is awkward. One agency of the federal government is suing a company for fraud while another agency continues to endorse it.

On Monday in Los Angeles, the Department of Justice sued Standard & Poor's and its parent McGraw-Hill for $5 billion. The claim is that S&P committed civil fraud when it issued high credit ratings on mortgage-related securities prior to the financial crisis of 2008. Sixteen states and the District of Columbia have piled on the suit.

No doubt investors who relied on the opinions of S&P and the other big credit-rating agencies, Moody's and Fitch, suffered terrible losses during the crisis. That was in part because the federal government forced investors to rely on them. Longstanding rules at the Securities and Exchange Commission and other agencies required institutions to hold assets graded highly by these government-approved rating agencies.

And to this day, more than two years after the Dodd-Frank law ordered their repeal, SEC rules still force institutions to follow the advice of these government-anointed credit raters. Therefore the more appropriate defendant for Monday's lawsuit would be the SEC. But as a modest first step before suing a company for $5 billion, shouldn't the government at least stop mandating its products?


We've long argued that the government should not endorse any company's opinions about credit risk, which at the end of the day is all a credit rating is—an opinion. And for that reason the government will not have an easy time making a fraud case.

Justice quotes internal emails from S&P personnel suggesting that, in its desire to win rating assignments from the investment banks that created securities, S&P was too generous in handing out high grades. For its part, S&P said in a Tuesday statement, "Claims that we deliberately kept ratings high when we knew they should be lower are simply not true."

If a publisher deliberately misleads, it loses its First Amendment protection. S&P concedes "there was robust internal debate" inside the firm but says it "applied the collective judgment of our committee-based system in good faith."
U.S. Attorney General Eric Holder.
Some of the emails in the government suit do look bad, at least as presented in the lawsuit and just like a lot of the rating-agency internal emails that the SEC released in a 2008 report. In fact, some of the same internal S&P messages from that five-year-old report are now reprinted in the new lawsuit.

So why wasn't a federal case made in 2008 or 2009 or 2010 or 2011 or 2012? In the United States it has always been difficult to prosecute publishers of financial opinions for securities fraud. Yes, the SEC has sometimes successfully prosecuted the proprietors of sham newsletters that touted stocks with bogus claims while secretly accepting payments from the companies being hyped.

But everyone already knows the big credit raters get paid to issue their opinions. And courts have often looked askance at broadly using the laws on securities fraud to go after people outside of the business of issuing, underwriting and dealing in securities.

This may be why the SEC, which had been investigating the credit raters, is not part of this week's lawsuit. Justice is instead trying to break new ground by using a 1989 statute intended to prevent bank fraud. Since federally insured financial institutions were among those who relied on credit ratings, argues Justice, S&P can be charged with fraud.

The suit names a specific credit union in California as an alleged victim. In other words, the government that keeps blaming the bankers for the crisis is now painting banks as the victims of rating agencies whose opinions the banks were ordered by the government to follow.

There are other disturbing questions related to the timing and the target of this federal civil prosecution. S&P's attorney Floyd Abrams tells us that "things seemed to rev up in terms of the intensity" of the federal investigation after S&P's historic downgrade of United States credit following Washington's debt-limit fight in 2011.

Meanwhile, a McClatchy Newspapers report says that it was around that time that Moody's, which did not downgrade the government, was dropped from the federal investigation. Ask any investor and he'll likely tell you that Moody's was equally awful in forecasting the mortgage debacle.

Speaking of the debt-limit fight, that's also coincidentally when White House Chief of Staff Jack Lew was aggressively promoting the President's campaign to prevent entitlement reform. Mr. Lew had worked in the heart of Citigroup's subprime investment factory, and the President has not only been willing to forgive and forget. He's even nominated Mr. Lew to become Secretary of the Treasury. But the company that put a shot across the Beltway bow over deficit spending is now the only target of a credit-ratings prosecution.

Why not just take away its government-enforced advantage instead? Both regulators and regulated institutions still yearn for the ability to outsource the tough decisions on credit risk to some certified experts. But it's folly to think that some anointed class can ever be counted on to warn of all potential default dangers.

If prosecutors continue to focus on how the rating process works, they may allow Washingtonians to celebrate downgrade payback, but they won't serve investors or taxpayers. Americans will benefit most when few people care how the rating agencies operate, because their judgments won't be that important.

February 7, 2013 6:28 pm

A case to reset basis of monetary policy
The current regime is meant to stabilise inflation and help stabilise the economy. It has failed

Are the targets and instruments of the UK’s monetary policy frameworkfit for purpose”? For once, this ugly phrase sums up the predicament well. With the economy in the doldrums and the arrival of Mark Carney as governor of the Bank of England in July, this is the ideal time for a rigorous, comprehensive and open debate.

As Mr Carney stated in testimony before the UK parliament’s Treasury select committee, the current framework is “flexible inflation targeting”.

In written evidence, he noted that “under flexible inflation targeting, the central bank seeks to return inflation to its medium-term target while mitigating volatility in other dimensions of the economy that matter for welfare, such as employment and financial stability. For most shocks, these goals are complementary. However, for shocks that pose a trade-off between these different objectives, or that tilt the balance of risks in one direction, the central bank can vary the horizon over which inflation is returned to target.”

Mr Carney considers flexible inflation targeting the “most effective monetary policy framework implemented thus far. As a result, the bar for alteration is very high.” He agrees, then, with Sir Mervyn King, his predecessor, who argued in January that “the anchoring of inflation expectations has been the most successful aspect of the inflation targeting regime ... It would be irresponsible to lose that.”

Yet proponents of the current regime (of which I was one) justified it not only on the proposition that it would stabilise inflation, but that it would help stabilise the economy. It failed to do so. In terms of lost output, the current slump is far worse than the inflationary 1970s and disinflationary early 1980s.

Even with growth at 1.5 per cent a year from now on, output would return to its level of the first quarter of 2008 only in the first quarter of 2015: in brief, seven lost years. This is abysmal, even if a productivity collapse (with worrying longer-term implications) shielded employment.

Moreover, even if one believes that today’s fashionable nostrum – “macroprudential regulation” – would have prevented this dire outcome, what should be done today, while the economy is trapped in a post-bubble slump? In written evidence, Simon Wren-Lewis of Oxford university argues that there is now “a clear conflict” between what a sensible UK monetary policy would be doing and what is actually happening. “Inflation targeting in the UK is not working, and something needs to change,” he writes. I agree.

So what is to be done? First, there needs to be a government-led assessment of the inflation-targeting regime, particularly of how well it operates while interest rates are at their lower bound. Second, the BoE has to reconsider how it develops and communicates policy during this exceptional period, including its exit from unconventional policies.

Finally, as Adair Turner, chairman of the Financial Services Authority, argued in an important lecture this week, even greater attention needed to be paid to the “how” of monetary policy in exceptional times than to its targets. In particular, he argued, money creation was a legitimate and powerful tool, in such circumstances.

Altering the longer-term regime would rightly take time. This is most obvious if one considers a popular alternative: a shift to targeting nominal gross domestic product. Yet, as Charles Goodhart of the London School of Economics and co-authors note in a recent paper, this attractive idea has drawbacks: the target is far less transparent than prices; the data are not only published quarterly, but are constantly revised; the impact on expectations might even be highly destabilising; and it would be extremely difficult to fix on a target for the growth or level of nominal GDP, given the uncertainties about potential real growth and the fact that nominal GDP is now 13 per cent below the pre-crisis trend. The difficulty of agreeing quickly on any alternatives might rule the notion out for immediate needs.

If so, the focus, particularly of the BoE, should now be on shifting expectations and making policy more effective. The least that should be done would be to make the Monetary Policy Committee’s expected path of interest rates more transparent and, as the US Federal Reserve has done, indicate the triggers for subsequent tightening. One way to reinforce credibility of commitments would be to indicate that the MPC is focusing on the rate of rise in labour earnings, as an indicator of inflationary pressure, as well as the misleading consumer price index.

Yet I agree with Lord Turner that the even more important question is how to make any policy effective. This, inevitably, raises questions about how monetary policy works in an environment of ultra-low interest rates. Lord Turner thinks the unthinkable: namely, monetary financing of the fiscal deficit. So should policy makers. They have to think afresh. If not now, when?

Copyright The Financial Times Limited 2013