Offshore yuan money market rates rose this week ahead of the inclusion of Chinese stocks in MSCI indexes, which is expected to drive strong demand for the currency, although analysts say recent central bank moves will prevent a liquidity crunch. One-year forwards on the offshore yuan, or CNH, stood at 915 points on Friday afternoon, compared with its closing price of 850 points a week earlier. The price of one-year offshore yuan forwards has fallen by about one-third so far this year.
MSCI said on May 15 that it would include 234 yuan-denominated stocks, or China A-shares, in its benchmark Emerging Markets and All Country World Index indexes from June 1. The inclusion will represent an aggregate weight of 0.39 percent in the MSCI Emerging Markets Index at an initial 2.5 percent partial inclusion factor.
Inclusion is expected to lead to a surge in foreign money flows into the A-shares, with the bulk of flows taking advantage of cross-border stock connect schemes with Hong Kong. To head off a crunch caused by spiking demand for offshore yuan, the People's Bank of China (PBOC) last week introduced measures to support cross-border fund flows, allowing banks involved in offshore yuan clearing and settlement to tap onshore liquidity. "The changes should greatly relieve liquidity pressure on the offshore CNH market, and reduce the upside risk to CNH forward points," said Frances Cheung, head of macro strategy for Asia at Westpac Institutional Bank in Singapore.
"In particular, offshore investors under Stock Connect are allowed access to onshore FX market for funds and FX hedges. This should mean the renminbi funds for northbound flows can be sourced from onshore CNY, not necessarily withdrawing liquidity from CNH," she said.
The cost of borrowing yuan in Hong Kong eased over the course of the week, with the rate for overnight contracts at 3.21467 percent on Friday, from 3.37367 percent a week earlier.
As well as helping to avoid an offshore crunch, improved onshore access is likely to support the onshore yuan's value. "We expect the CNH-CNY spread to narrow as part of the CNH buying flow for A-share would divert to CNY market," said Ken Cheung, senior Asian FX strategist at Mizuho Bank in Hong Kong.
The spread between onshore and offshore rates was at 54 pips early Friday afternoon, with CNY trading at a discount to CNH. Primary onshore money rates rose this week as the PBOC drained a net 30 billion yuan from money markets.
The volume-weighted average rate of the benchmark seven-day repo traded in the interbank market, considered the best indicator of general liquidity in China, was 2.7808 percent. That is 8.5 basis points higher than the previous week's closing average rate 2.6962. The Shanghai Interbank Offered Rate (SHIBOR) for same tenor rose to 2.7940 percent, up 2.6 basis points from the previous week's close of 2.7680 percent.
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