PBOC discusses opening offshore yuan market

Bloomberg

China’s central bank said it has met with onshore lenders to discuss allowing them to trade in the offshore yuan market, a move that would accelerate convergence between the country’s two exchange rates.
As the country increasingly opens up its currency market, Chinese commercial banks have a growing need for better integration between the onshore and offshore markets, the People’s Bank of China said in a statement on its official
microblog.
Such a relaxation would mark another step to bring the two rates into line after China said earlier it will allow more foreign institutions to trade the onshore yuan. While moves in the onshore rate are influenced by a trading band anchored around the daily fixing and occasional intervention, the freely traded currency in Hong Kong has been more volatile. The gap between the two spot rates widened to a record in January as global investors rushed to sell the currency amid an abrupt weakening of the fixing.
“The endgame is the absorption of the offshore market into the onshore market,” said Tim Condon, head of Asian research at ING Groep NV in Singapore. “I infer that the PBOC views expectations about the onshore yuan as sufficiently settled that allowing domestic banks to trade in the offshore market will not lead to destabilizing capital flows.”
While the yuan fell to a five-year low last week, there is little sign of the panic seen in January and capital outflows are slowing. The currency will weaken 1.9 percent for the rest of the year from 6.5754 per dollar on Tuesday, according to the median estimate in a Bloomberg survey of analysts.
The International Monetary Fund had pointed to the offshore-onshore spread as one of the issues affecting China’s entry to its basket of reserve currencies, saying that the gap would make the offshore yuan an imperfect hedge for onshore exposures. The yuan is set to enter the IMF’s Special Drawing Rights in October, joining the dollar, euro, yen and pound.
The PBOC said the discussions were about an “orderly” participation in the offshore market. Such wording suggests the relaxation may only cover transactions in the current account rather than those in the capital account, which will only be included eventually, according to Christy Tan, head of
markets strategy in Hong
Kong at National Australia Bank Ltd.
The offshore yuan was 0.1 percent weaker than its onshore counterpart on Tuesday, down from an average 0.3 percent in 2015.
“While details are scarce at this point, the key word is ‘orderly,’” Tan said. “The potential effect of this allowance would be an even narrower gap between the two rates and eventual convergence.”