Jun 3, 2005

Renminbi NDF Growth

From Cynic's Delight:
Second, there is a growing market for non-deliverable forward contracts for Chinese renminbi. NDF contracts are traded offshore and are used to hedge against exchange rate movements in non-convertible currencies. In this case they are agreements to buy or sell renminbi at a specific future date at a specific exchange rate. At maturity, the contracts are settled using only the hard currency, usually dollars, and no renminbi are deliverable. Dollar payments are made or due based on the difference between the prevailing spot rate and the NDF rate. If, at maturity, the renminbi has appreciated against the dollar, the holder of the NDF will be paid a certain dollar amount. If the renminbi has depreciated, the holder will owe a certain dollar amount.

The BIS report suggests that the growth of these renminbi NDF markets presents one of the few real price signals from the markets as to future expectations of the renminbi exchange rate. Billion dollar daily turnovers are now common, and most of the activity seems to be hedging against a renminbi revaluation. Moreover, the report has uncovered evidence of a movement away from strictly dollar oriented exchange rates among Asian currencies towards an "effective exchange rate orientation." In other words, Asian exchange rates are seeing higher volatility against the dollar as compared to between Asian currencies.

This is important, as it is evidence of market signals that the renminbi will play an increasingly important role in determining exchange rates across East Asia. Considering the rising trade flows between China and the other Asian economies, this only makes sense. It is becoming increasingly likely that a renminbi revaluation could allow other Asian currencies to rise against the dollar while maintaining (or at least limiting the rise in) their renminbi exchange rates.

Still, so long as the Chinese prevent current account convertibility, they will be free to determine exchange rate and monetary policy as they see fit, without bowing to pressure from the financial markets or foreign governments. But as China's share of international trade grows, renminbi turnover will inexorably rise along with it. Importers and exporters will find increasingly sophisticated ways to manage their foreign exchange needs, and capital flows should prove harder and harder to manage. In the long run, international financial markets will provide the real challenge to Chinese efforts to maintain control over their exchange rate and monetary policies, and not foreign governments.

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