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l Global Research l

Important disclosures can be found in the Disclosures Appendix All rights reserved. Standard Chartered Bank 2011 research.standardchartered.com

Contents

Focus – Becoming the world‟s currency 2

CNH market development – Rebuilding after

the storm 8

FX – Our new CNY and CNH forecasts 12

Credit – Value in Dim Sum bonds 16

Economics – The meaning of micro-loosening 22

Appendix 27

Trade-weighted CNY NEER above its

June 2010 post-de-peg level

Sources: Bloomberg, Standard Chartered Bank

105

110

115

120

Jul-09 Jan-10 Jul-10 Jan-11 Jul-11

CNY NEER -Our daily estimate

BIS CNY NEER -Monthly

Key strategies

Now Target Stop-loss

Credit

Buy EVERRE 2014 synthetic CNY outright

80.3 100 70

FX

Corporates with future USD receivables/ CNY payables should hedge in USD-CNH forwards

Eddie Cheung, +852 3983 8566

[email protected]

Kelvin Lau, +852 3983 8565

[email protected]

Robert Minikin, +852 3983 8567

[email protected]

Shankar Narayanaswamy, +65 6596 8249

[email protected]

Stephen Green, +852 3983 8556

[email protected]

Vijay Chander, +852 3983 8569

[email protected]

The Renminbi Insider | 09:00 GMT 21 November 2011

Rebuilding after the storm

Highlights

Global market volatility finally hit the offshore Renminbi market in late September.

CNH depreciated sharply, Dim Sum credit sold off, and participants were left

wondering how viable the CNH market was. The exhaustion of the conversion

quota for CNY trade exacerbated the volatility. The quota has been increased, but

corporates are reconsidering decisions to convert trade to CNY. We propose

mini-reforms to rebuild confidence, including the elimination of the quota.

We report on the continuing debate in Beijing on CNY internationalisation. Critics

argue that the resulting faster build-up of FX reserves and the potential for more

„hot money‟ flows are significant downsides. Some at the People‟s Bank of China

appear to view the market as a means of pushing through needed financial

reforms onshore.

We have adjusted our CNY and CNH FX forecasts for 2012, although we still

expect Beijing to allow gradual appreciation against the dollar. We now forecast

that the CNY will appreciate only 3.3% in 2012, to 6.12 at year end, following a

4.5% move in 2011.

We see value in the Dim Sum bond market after the sell-off in September and

October. We recommend the MCD 13 denominated in CNH, which has widened

substantially. The RESOUR 15 in USD clearly offers value compared to the

RESOUR 15 in CNH, both on an outright and an asset-swapped basis.

Monetary policy is becoming looser, gradually. In the run up to Chinese New Year

(Jan 23), liquidity conditions will be volatile but we do expect a required reserve

ratio cut before the CNY holiday. Interbank rates will be lower after that.

The Renminbi Insider

GR11NV | 21 November 2011 2

Focus – Becoming the world’s currency

Reserve currency hopes for the CNY face enormous challenges

We do not understand all the fuss about the SDR

CNH may help domestic reforms, but it is unclear exactly how

Big hopes are being pinned on the Chinese yuan (CNY). Some analysts, both in

China and overseas, believe that it stands a good chance of becoming a reserve

currency. This will take time, but many are impatient, believing that the world

desperately needs a new reserve currency as long-term fiscal decline in the US and

Europe undermines „old world‟ currencies.

On the other side of the debate, some in Beijing worry that the internationalisation of

the CNY will contribute to the fall of China‟s economy. They are worried by the „hot

money‟ that could flood in and out of the country through holes in the capital account

that the CNH market has created.

We recently participated in a conference in Beijing at which policy makers and

academics discussed these questions and more. The discussion ranged from the

problem of cross-border arbitrage flows to the need for wholesale reform of the

international financial system. Here, we report on the discussion and add some views

of our own.

Reforming the international financial system in the morning

Let us start with the big picture. Many at the event expressed considerable disquiet

about the dollar-based international financial system. This concern is not just heard in

Beijing. Many seminar participants argued that the dollar‟s status as the main global

reserve currency was being undermined by the US‟ fiscal position and monetary

policy. Most participants agreed that the Triffin Dilemma – the ability of a reserve

currency to raise unlimited external debt, which eventually dooms its government to

becoming too indebted – was at the root of the dollar‟s current difficulties. US

household savings rates might have adjusted upward in the last two years, but the

increase in the government‟s net borrowing more than makes up for this.

Chart 1: Our estimates of China’s reserve holdings of US securities

USD bn

Sources: Bloomberg, Standard Chartered Research

0

500

1,000

1,500

2,000

2,500

Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11

Total US securities holdings (TIC reported)

Total UST holdings (TIC reported)

Total UST holdings (adding London)

Total US securities holdings (adding London)


[email protected]

Ambitions for the CNY are big and

small – and are hotly debated even

in China

The international financial system is

not working, but neither would the

alternatives



Washington‟s „Weak Dollar‟ policy also complicates policy making in the current „two-

speed‟ global economy, it was argued. If the US implements QE3 (as we expect it to in

early 2012), and possibly QE4 and QE5 later, some believe the resulting global inflation

would make life very difficult for still-growing emerging markets. Policy makers there

are left facing a volatile world: one day they worry about a deflationary collapse in

global demand, the next, an inflationary spiral fed by the printing of US dollars (and

possibly euros too). Some participants argued that there was a fatal contradiction

between the domestic needs of the US economy and its global responsibilities. Another

noted that issuing a reserve currency was not a privilege but an “exorbitant curse”.

As an aside, Lawrence Summers, then President Obama‟s chief economic advisor,

made the point at a Standard Chartered event in Hong Kong earlier this year that

there is nothing to stop EM countries from appreciating their currencies if they are

worried about importing inflation. And as Paul Krugman likes to say, no one forced

EM central banks to buy so much US debt. We show China‟s holdings of US

government debt in Chart 1.

So what to do? The answer is tricky because at least two things are required from

any alternative to the current global system:

The countries that print reserve currencies need to exercise restraint in the good

times in order to prevent inflation.

When faced with a liquidity crisis, reserve currency issuers need to be able to act

as lenders of last resort.

In other words, a reserve currency needs to behave very differently at different times.

The gold standard, for instance, is respected for fulfilling the first requirement but

utterly fails on the second.

At least two participants at the Beijing conference argued that consideration should

be given to an international reserve currency, as originally foreseen by John Maynard

Keynes in the 1940s. Two years ago, People‟s Bank of China (PBoC) Governor Zhou

Xiaochuan wrote about the possibility of reinventing the IMF‟s Special Drawing

Rights (SDR) as an international currency. The SDR is currently just a basket of

national currencies, and is only used as a unit of account when members contribute

funds to the IMF. This is a far cry from Keynes‟ idea of a truly global currency backed,

in effect, by a global central bank.

However, the practical difficulties of remaking the SDR are probably overwhelming. A

revived SDR would require sovereign governments and their central banks to give up

their independence, and an international central bank (a reinvented IMF?) to be able

to print money. This would require the bank to have revenue-raising ability.

Even if this was practical, one participant pointed out that the euro area – an alliance

of close neighbours – was having more than a few problems agreeing on how to run

its central bank. Asking countries with even more divergent interests to run a global

central bank would be asking for trouble, he argued.

So, frustration with the current system is met with the impossibility of radical change.

As far as the SDR goes, the CNY could perhaps be welcomed into the SDR basket in

a few years‟ time. IMF rules require that SDR basket currencies be fully convertible –

a reasonable requirement, since they are supposed to be easily used in a crisis. But

Reviving – and writing off – the SDR



even the CNY‟s entry into the SDR basket would amount to little more than a

diplomatic victory for Beijing, in our view.

A more practical alternative, which was widely discussed, would be a „multi-reserve-

currency‟ world. Barry Eichengreen, author of Exorbitant Privilege, a book on the rise

of the dollar, foresees such a world; on the face of it, this vision looks reasonable to

us. One conference speaker argued that it was time for large EMs to provide an

alternative to the dollar. In a multi-reserve-currency world, the hope is that

competition to attract investors would impose some discipline on sovereign

borrowers. Moreover, EMs still want to accumulate FX reserves to protect

themselves in the event of a financial crisis, and many hope to diversify their risks

away from the USD and the EUR. In such a context, the speaker argued that China‟s

internationalisation of the Renminbi was a global public good.

There are some problems with this argument, though. For starters, we already live in

a multi-reserve-currency world, and this has not prevented the issuers of these

currencies – the US, the euro area, the UK and Japan – from facing fiscal problems

and implementing loose monetary policy. We also note that China‟s own households

appear to lack confidence in the Renminbi as a store of value. They seem to put far

more faith in the country‟s residential housing stock. Chart 2 shows M2 growth in the

major economies. Even though China‟s printing of money has slowed, its M2 growth

was still worryingly high in 2009 and 2010. The amount of money (M2) in China today

has doubled since the same time in 2008. As we have pointed out before, China‟s

hopes for reserve currency status ultimately hinge on it having deeper capital

markets, an independent central bank, and a freer capital account.

There is clearly no easy solution to the troubles of the international financial system –

and as we prepare for more QE in the US and Europe, flows will become more

volatile. A radical change in the current international monetary system is unlikely, and

ultimately we will continue to have to rely upon central banks to act responsibly.

The CNY Special Economic Zone

The pros and cons for China of Renminbi internationalisation were a hotly debated

topic at the conference. (We note that PBoC officials prefer to talk about „cross-

border CNY settlement‟, but since a CNH market is now developing in Hong Kong,

this description seems a little tame.)

Chart 2: M2 growth is still fastest in China, thanks to credit expansion (% y/y)


Europe

Japan

China

US

-5

0

5

10

15

20

25

30

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

A world with multiple reserve

currencies is hardly a better

alternative

The pros and cons of pushing the

CNY offshore



For good or for bad, depending on one‟s perspective, China did not take the orthodox

advice that one should liberalise interest rates and remove capital account controls

before internationalising one‟s currency. Indeed, China may be the only example of a

government freely pushing the internationalisation of its currency while maintaining

capital controls.

Some seminar participants attempted to defend this approach with claims that China

always succeeded in carrying out reforms in its „own way‟. Other participants wanted

to understand the real costs and benefits of such an approach.

On the benefits side, PBoC officials claimed that CNY internationalisation was

demanded by the corporate sector – trading firms and companies investing overseas

wanted to reduce their FX risk. Long-term, China would enjoy clear advantages from

being able to issue a reserve currency (including seignorage, the ability to print

currency and push the cost of the resulting inflation onto others), but economists

debate the scale of these benefits. One participant noted that reserve currencies tend

to benefit from inflows of liquidity when a crisis hits. This benefit can be significant –

witness how US government bond yields have been held down despite market

concerns about the US fiscal position. China‟s leaders had taken note of this

phenomenon, the participant claimed.

The CNY internationalisation policy also has downsides for China. Most participants

agreed that internationalisation requires full opening of the capital account. One

concern is that global capital will then arbitrage differences between the on- and

offshore markets. One paper presented at the conference detailed how the offshore

CNY market is being successfully kept separate from the onshore market, at least for

now. The same government bonds maturing in early 2015 yield 1.9% offshore and

3.46% onshore, which suggests that capital controls are working to some extent. But

they are leaky, and indirect arbitraging is possible.

Another frequently mentioned downside of CNY internationalisation is increased FX

reserve accumulation by the PBoC. When importers buy USD offshore rather than

onshore, more onshore dollars have to be sucked up by the central bank. Importers

were motivated to do this in H1-2011 thanks to the CNH premium onshore. In recent

Chart 3: China’s build-up of FX reserves – watch the ‘everything else’ category

USD bn

Sources: CEIC, Standard Chartered Research

-200

-150

-100

-50

0

50

100

150

200

250

Q1 2008 Q3 2008 Q1 2009 Q3 2009 Q1 2010 Q3 2010 Q1 2011 Q3 2011

Trade (BoP) Net FDI Returns Everything else

China accumulated another USD

84bn of FX reserves in the first

three quarters of 2011



weeks, with the CNH now in discount, exporters have had an incentive to receive

CNH rather than USD offshore. This has resulted in a reversal of USD selling in

China, relieving pressure on the PBoC in Q3, as Chart 3 shows. We estimate that the

increase in FX reserves related to trade in CNH in the first three quarters of 2011

was about USD 83bn, some 27% of total FX reserve accumulation during the period.

Another conference participant argued that there is no fundamental demand for CNY

offshore at present – everyone just wants to hold an appreciating currency, and once

expectations shift, the „internationalisation‟ process will reverse. He saw only

speculative motives on the part of importers to invoice trade in CNY in H1, and for

owners of CNH assets.

We suspect that this view is a little too sceptical. Exporters receive real benefits from

converting to CNY invoicing – most importantly, quicker payment. This is because

payments in CNY from overseas do not need to be kept in a verification settlement

account for 10 days, as foreign-currency payments do; administrative costs can be

saved as well. Such savings can be passed on to buyers.

Moreover, if China‟s economy continues to grow, relative productivity differentials

should result in continuing appreciation pressure on the real effective exchange rate.

In such an environment, the incentive to hold CNY should not vanish. The PBoC only

needs use of the CNY as an invoicing currency to reach critical mass at some point

in order for the CNY to become a normal currency for trade and investment, and its

job will have been done. (But as we note in the CNH market development part of The

Renminbi Insider, the regulators still have some work to do.)

An exceptionally cunning plan?

Given the even balance between the economic pros and cons, some conference

participants wondered if there might be something else behind Beijing‟s push for

CNY internationalisation. According to one theory, CNY internationalisation is a

means of pushing domestic reform. The broad idea here is that, rather like its entry

into the WTO, China‟s gradual integration with global financial markets will induce

positive domestic change.

The explanation is elegant, but how could it work in practice? We can think of a few

possible mechanisms:

Once reserve-currency status is agreed as a top political priority, the leadership

will have to consider the need for deeper capital markets, and perhaps even

greater independence for the central bank.

A successful and relatively free CNH capital market in Hong Kong will induce

Shanghai and other cities to lobby for financial-sector liberalisation back home.

A controlled experiment offshore can demonstrate that a freer financial market

does not have to be destabilising, and thus win the confidence of senior leaders.

China‟s financial institutions and corporate sector will get used to the freer CNH

market and will also lobby for liberalisation onshore.

Regulators can learn how to regulate complex CNH instruments from the Hong

Kong markets.

People hold CNH because of

appreciation expectations – so what

happens when those expectations

reverse?

Do the reformers have a cunning

plan?



If this is indeed the thinking, we have two things to say. First, it is a long-range plan

that lacks the rule-based structure the WTO provided, so it is difficult to see how it

will develop. Second, we cannot help but think about the potential downsides. For

instance:

Opening up the capital account might make domestic interest rate reform –

which implies higher interest rates – more, not less, difficult. (We discussed how

rate reform should and could work in the last issue of The Renminbi Insider.)

The disjointed CNY/CNH market could create incentives for arbitrage activities,

which would undermine the credibility of the experiment.

Holes in the capital account could introduce more volatility to the macro-

economy.

All the time and effort put into CNY internationalisation reforms may divert from

policy makers from the serious tasks of allowing more interest and exchange

rate flexibility.

There are potential downsides to

this strategy too



CNH market development – Rebuilding after the

storm

The recent bout of CNH volatility has shaken the market

The expanded trade conversion quota needs to be reformed

We also believe the administrative burden for CNY settlement is now

too high

The offshore CNY (CNH) market was finally hit by global market turbulence in late

September, and Dim Sum bonds and CNH were sold off along with the rest of the

Asian FX and credit universes.

This is clearly a setback for the market. As a result, momentum has been lost on the

CNY trade settlement and Dim Sum bond market fronts. The presumption that CNH

should always trade at a stable premium to onshore CNY, which anchored many

investors‟ interest in the market, disappeared. But Beijing appears intent on

continuing to support the market. We believe the speedy formalisation of the CNH

FDI rules illustrated this. Moreover, the People‟s Bank of China has announced its

aim of making the Renminbi the world‟s third-largest trade currency (surpassing the

Japanese yen) within three to five years. It is also important to note that CNH did not

sell off as much as some other Asian currencies, and even at the worst of times, it

remained within 3% of the onshore CNY.

The onus is now on the regulators in Hong Kong and Beijing to respond proactively,

as they have done in the past, to strengthen the market further. Specifically, the CNY

trade settlement conversion quota system did not work well during the recent

volatility, as it was unable to respond to fast-changing market conditions. The

renewal and expansion of the quota for Q4, while a good start, is not a permanent

solution. The recent clarification of which trades are eligible to tap this quota is

welcome, but does little to reduce the system‟s inherent complexity and

documentation requirements. Worries about another exhaustion of the quota will

keep CNH market participants cautious, and could cause corporates to reconsider

plans to convert their invoicing to CNY. In addition, CNY appreciation expectations

are weakening, which will reduce interest in the CNH market.

Table 1: CNH settlement to Q3-2011 (CNY bn)

Item Q3-2011 Q2-2011 q/q (%)

Cumulative

Cross-border Renminbi trade settlement (since beginning of pilot scheme)

2,050.7 1,467.3 + 39.8%

Renminbi overseas direct investment (Q1-2011 onwards)

10.9 5.4 + 101.9%

Quarterly

Cross-border Renminbi trade settlement 583.4 597.3 - 2.3%

w/w merchandise goods trade 396.9 455.7 - 13.0%

services trade 186.5 141.6 + 31.7%

% of China trade 10.0% 10.1% ---

Cross-border Renminbi remittances 419.6 409.0 + 2.6%

w/w inward remittances (China IRTT) 156.9 103.8 + 51.2%

outward remittances (China ORTT) 262.7 305.2 - 13.9%

IRTT:ORTT ratio 1 : 1.7 1 : 2.9 ---

Sources: PBoC, Standard Chartered Research

Kelvin Lau, +852 3983 8565

[email protected]


[email protected]

CNH market development has

slowed, but the regulators could

restore confidence



Here, we quickly review CNH trade settlement progress in Q3, and then outline the

problems exposed by the recent market volatility. We suggest a mini-reform that

would help prevent a repeat of the September mess.

CNY settlement update

Q3-2011 saw the first q/q decline in the amount of CNY cross-border trade

settlement, to CNY 583bn from CNY 597bn in Q2, as Table 1 shows. About 10% of

China‟s trade is currently denominated in Renminbi. Services now account for almost

one-third of this settlement volume.

There was a small increase in Renminbi remittances in Q3, along with more evidence

of rebalancing – the ratio of exports (inward payments of CNH) against imports

(outward payments of CNH) was 1.0:1.7 in Q3, down from 1.0:2.9 in Q2. Partly as a

result, the total amount of CNH deposits in Hong Kong has basically stabilised over the

last couple of months. By end-September, Hong Kong had CNH 622bn of CNH

deposits.

The trade conversion quota is bigger but not big enough

All of Asia suffered from heightened bearish sentiment in late September. Making

matters worse for the CNH market, just after the CNH discount emerged, the clearing

bank‟s CNY trade settlement conversion quota was exhausted. This quota limits the

clearing bank‟s commitment to allow banks participating in the trade settlement

scheme – after they net out eligible trade-related conversion needs from their clients

– to square the resulting net CNY positions with the clearing bank. Such trades are

done at the onshore CNY price (the alternative is to trade at the offshore CNH price,

at which everyone who is not involved in CNY trade settlement deals). A similar

quota system is in place between offshore banks and so-called onshore agent banks.

As soon as CNH moved into discount against the CNY, corporations with conversion

needs underlined by genuine trades rushed to move their transactions through the

settlement bank. The onslaught of one-sided flows quickly exhausted the CNY 4bn

quota. Once the quota was used up, flows moved back into the CNH market, further

weakening the currency. (Trade-related CNY cross-border remittances were

unaffected because the quota only applies to offshore conversion, not cross-border

payments.) As Chart 1 shows, CNH moved aggressively against CNY.

Chart 1: The CNH premium suddenly disappeared and is now coming back


USD-CNY

USD-CNH

0.0

0.2

0.4

0.6

0.8

1.0

1.2

6.30

6.35

6.40

6.45

6.50

6.55

Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11

The exhaustion of the trade

conversion quota was a big

problem for the market



In early October, the quota was renewed and increased to CNY 8bn for Q4-2011,

from CNY 4bn for each of the first three quarters of the year. Quotas granted to

onshore agent banks enjoyed similar treatment. Some measure of calm has returned

to the market, but participants remain cautious.

Lingering fears put corporates off CNY settlement

There is still a sense that the quota might be exhausted again soon. This is not

inconceivable given persistent global risk aversion. CNY letters of credit (L/Cs)

previously issued onshore and discounted offshore – which flourished in H1-2011

before winding down somewhat in Q3 – are likely to guarantee a constant stream of

Renminbi payments offshore in the coming months as the L/Cs come due. This

Renminbi will be eager to tap the clearing bank quota as long as the CNH spot

discount remains.

Under normal market circumstances, the ability of corporations to make trade-related

cross-border transfers to and from mainland China stabilises the CNH market. When

CNH trades „rich‟ to CNY onshore, mainland importers will buy more dollars via their

offshore subsidiaries, boosting offshore CNH liquidity and reducing the premium.

When CNH is in discount, mainland exporters will buy CNH offshore, pushing up

CNH. The clearing bank conversion channel (when it is open) stands behind the

market to guarantee that those conducting trade in CNY are protected.

In September, though, the quota system added to the market‟s volatility. The rush to

tap this supplementary conversion channel exacerbated one-sided flows, quickly

rendering the quota‟s „netting off‟ mechanism ineffective.

As long as the quota is smaller than cross-border trade flows (about CNY 200bn in

September), the risk of quota exhaustion will continue to loom. The very fact that the

offshore market can diverge from the onshore market by 3% means that access to

the onshore market FX rate can be closed during volatile periods – a huge

disincentive for big corporates to invoice in CNY. A 3% loss on a large trade flow is a

significant amount of dollars. Large firms need to be assured that they can access

the onshore rate from offshore before they move to CNY invoicing.

At the very least, a bigger settlement quota is needed. We also believe the quota

system should become simpler and more transparent. One could go further and

argue that there is no real need for a finite quota, as long as there are water-tight

rules to ensure that all of the flows tapping the conversion quota are backed by

genuine trade. Removing the quota while insisting that third-party trade documents

are in place (enforced by spot checks with large penalties in the event of

misbehaviour) would be a good way of solving the problem, we believe.

We believe such spot-checks would be preferable to the recent move by the Hong

Kong authorities to require documentation of each FX trade done under the trade

settlement quota. These new rules have raised issues for corporates involved in the

scheme and for those looking to reconvert into CNY. The feedback is that such

documentation requirements are burdensome and are causing some to reconsider

their involvement in the scheme, or to look at other offshore centres than Hong Kong.

Fears that the quota could be

exhausted again are deterring

companies from converting trade

settlement to CNY, we believe

We believe the quota either needs

to be increased a lot, or it needs to

be removed completely



Enlarging or even removing the trade settlement quota, as well as fine-tuning

documentation requirements, would set up the CNY settlement scheme to grow

again. Without such changes, we believe fewer corporates will convert into CNY and

the overall CNH market will grow more slowly. If the Renminbi is indeed to become

the world‟s third most popular trade currency, there is some rebuilding to be done

after the recent storm.



FX – Our new CNY and CNH forecasts

We scale back our forecasts for CNY gains on trade, inflation outlook

CNY gains may slow in Q1 before re-accelerating later in 2012

CNH premium over CNY is likely to be restored in early 2012

Corporates should use CNH to hedge future onshore CNY payables

H1-2012 looks set to bring a significant slowdown in the pace of CNY appreciation

versus the US dollar from the 5.5% annual pace that has prevailed since the mid-

June 2010 de-peg. While the case for a marked slowdown is broad-based, it is

dominated by prospects for China‟s balance of payments and inflation dynamics.

Current account: We forecast a current account surplus of 2.3% of GDP in 2012,

down from 3.6% in 2011. In 2011, China‟s trade balance was basically flat in Q1 (a

deficit of USD 0.71bn), and the monthly surplus did not exceed USD 20bn until June.

Given weak external demand, H1-2012 should look similar, though much will depend

on imports, which will likely be weaker than in H1-2011. Q3-2011 balance-of-

payments data pointed to a pick-up in foreign companies remitting profits offshore. If

this trend continues, alongside weaker FDI inflows within the capital account, CNY

appreciation pressures will dissipate. In late September 2011, a ramp-up of

remittances (along with the disruption of the CNH market) pushed up onshore USD-

CNY, despite lower fixes, as Chart 2 shows.

Inflation: The desire to contain imported inflationary pressures reinforces the case

for CNY appreciation onshore. Commodity prices have retreated, and the broader

domestic inflation picture is now much more benign – we expect headline inflation to

have eased to 4.5% by end-2011 and to fall significantly further over the course of

H1-2012.

The geopolitical aspect of the USD-CNY path is the most difficult to call. The

European sovereign debt crisis and China‟s potential role in providing Europe with

loans for the European Financial Stability Facility reinforce its ability to shrug off

international pressure for CNY appreciation. However, US (and IMF) criticism of the

slow pace of CNY appreciation has not abated, and potential Congressional approval

of the US currency manipulation bill will limit China‟s room for manoeuvre. The

Chart 1: USD-CNY and annualised pace of CNY

appreciation (versus USD) since de-peg

Chart 2: USD-CNY daily close vs. PBoC daily fix – daily

and 5-day MA (%)

Sources: Bloomberg, Standard Chartered Research Sources: Bloomberg, Standard Chartered Research

0%

3%

6%

9%

6.3

6.4

6.5

6.6

6.7

6.8

6.9

Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11

USD-CNY

Annualised pace of appreciation (RHS) Daily 5-day MA

-0.4

-0.2

0.0

0.2

0.4

0.6

Jun-10 Oct-10 Feb-11 Jun-11 Oct-11

Weak side of USD-CNY daily trading band

Robert Minikin, +852 3983 8567

[email protected]

Eddie Cheung, +852 3983 8566

[email protected]

A significant slowdown in CNY

gains is expected amid persistent

trade deficits in H1-2012 and an

extended downswing in headline

inflation

Broader geopolitical arguments still

favour CNY gains versus the USD,

however mild



balance of risks suggests that the CNY will be put on a gradual appreciation path

against the US dollar. The pace of appreciation will be fast enough to appease

overseas pressure, but not fast enough to damage China‟s exporters. We believe

that even if China‟s FX reserves decline mildly in H1, the CNY will not significantly

depreciate against the USD.

Our new CNY-USD forecasts scale back the CNY‟s quarterly gain in Q4-2011 to 0.97%

(compared to gains of 1.3% in Q2 and Q3-2011). We expect quarterly gains to slow

to just 0.64% in H1-2012. While recent declines in China‟s current account and trade

surpluses create greater uncertainty for the CNY‟s path further out, these trends have

been the product of a powerful investment boom. As this fades, the current account

surplus should stabilise and rebound, creating the conditions for persistent CNY

gains in the medium term. These will be reinforced by healthy domestic productivity

growth at home and sustained overseas demand for CNY as a financial asset.

The fate of the CNH premium

The powerful burst of risk aversion across global financial markets in August and

September reached a crescendo in late September and finally prompted a bout of

instability in CNH-denominated assets, including FX. The USD-CNH „general

purpose‟ rate in Hong Kong hit at least 6.56 intraday on 23 September, and there

were reports of scattered trades in the mid-6.60s (putting CNH at a discount of close

to 4% to CNY). While it is unclear whether disorderly market conditions sparked

official intervention, heavy USD-CNH selling by the clearing bank (and other

mainland China names) played a role in stabilising the market.

In our view, the marked CNH discount in September 2011 had the same significance

as the marked CNH premium in October 2010. It primarily reflected short-term

Table 1: USD-CNY and USD-CNH forecasts (end-period)

Table 2: Q4-2011 Q1-2012 Q2-2012 Q3-2012 Q4-2012 Q1-2013 2012 2013

USD-CNY 6.33 6.29 6.25 6.19 6.13 6.08 6.13 5.98

CNY (% q/q) 0.97 0.64 0.64 0.97 0.98 0.82 3.26 3.46

USD-CNH 6.34 6.275 6.235 6.175 6.115 6.065 6.115 5.965

CNH premium (%) -0.16 0.24 0.24 0.24 0.24 0.24 0.24 0.24

Source: Standard Chartered Research

Chart 3: USD-CNY, USD-CNH and CNH premium over

onshore USD-CNY (%)

Chart 4: CNH premium to CNY – Distribution by % of daily

observations since start of August 2010, by 0.5ppt gaps


USD-CNY

USD-CNH

CNH Premium (RHS)

-3%

-2%

-1%

0%

1%

2%

3%

6.3

6.4

6.5

6.6

6.7

Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11

0

10

20

30

40

50

60

3.0%2.5%2.0%1.5%1.0%0.5%0.0%-0.5%-1.0%-1.5%-2.0%

0.5% interval to:

0 to 0.5%

Gradual CNY gains are likely to

extend into the medium term

Global market turmoil prompted

powerful intraday surge in the CNH

discount to CNY



market illiquidity, rather than a sustained disruption to the mechanism of the offshore

market (or, indeed, the CNY trade settlement scheme). With CNY in Hong trading at

a discount to CNY in the onshore market, corporates with CNY payables have an

economic incentive to acquire CNY offshore and then make the cross-border transfer

into mainland China. This mops up the excess CNY offshore, bringing demand and

supply back into equilibrium. Banks‟ ability to arbitrage the onshore and offshore

CNY, alongside investors‟ willingness to invest in cheap CNH-denominated assets,

limits the extent of the CNH discount, even in the short term.

While the broader dynamic points towards CNH and CNY convergence, a couple of

factors suggest more market instability in the future. First, as we discuss elsewhere

in this issue of The Renminbi Insider, the possibility that the trade settlement quota

could run out again creates profound uncertainty over the USD-CNH market. Second,

and related to this point, banks have provided USD financing for exporters to China

(from Hong Kong) based on letters of credit (L/Cs) on the assumption that CNH

would be trading at a premium to the onshore CNY at the maturity of those L/Cs. At

some point, the L/Cs will mature, creating a lot of USD demand – which could quickly

use up the quota.

Our forecast profile incorporates a modest CNH discount into end-2011. The global

slowdown overshadows prospects for Asia ex-Japan currencies on this horizon, and

may also reduce appetite for CNH-denominated assets more generally. Next year,

we expect a modest CNH premium to re-emerge; it should stabilise at around 150

pips (0.24%). If onshore and offshore CNY were perfectly fungible, USD-CNY and

USD-CNH would simply converge. But in the current context of limited fungibility, the

positive carry in CNH-denominated assets, combined with expectations of persistent

CNY appreciation, justifies a very modest CNH premium.

Value in the CNY and CNH forward space

While volatile CNH pricing has made for tricky market conditions for investors, it has

been positive for corporate participants in the CNH market. Overseas investors and

corporations play markedly different roles in the offshore market. Overseas investors

holding CNH-denominated assets have exposure to the „general purpose‟ USD-CNH

spot rate. Their investment returns are driven unambiguously by the performance of

CNH. Corporates with onshore CNY payables, in contrast, have the opportunity to

Chart 5: USD-CNH curve has reshaped in past 2 months

USD-CNH forward curve is progressively more upward-

sloping

Chart 6: 1Y CNY appreciation discounted by USD-CNH

and USD-CNY non-deliverable 1Y forwards

Source: Bloomberg Sources: Bloomberg, Reuters, Standard Chartered Research

6.2

6.3

6.4

6.5

6.6

0.00 0.25 0.50 0.75 1.00

Years forward

15 Nov

3 Oct

15 Sep

-2%

-1%

0%

1%

2%

3%

4%

5%

Sep-10 Dec-10 Mar-11 Jun-11 Sep-11

USD-CNY 1Y forward appreciation vs. spot

USD-CNH 1Y forward appreciation vs. spot

Unpriced CNY appreciation

The CNH premium to CNY should

re-emerge in 2012



buy CNY in the offshore market and have an economic exposure to onshore USD-

CNY. Corporates should add to CNY cash balances in the offshore market when

CNH trades at a significant discount to CNY, as they will be able to use these funds

to make future onshore CNY payables.

The recent market volatility has also played a role in cheapening the CNY forwards in

both offshore markets – the USD-CNY non-deliverable forwards and the USD-CNH

deliverable forwards. In the deliverable context, the USD-CNH curve has typically

moved up and down in a broadly parallel fashion, creating periodic opportunities to

sell USD-CNH forward well above our forecast profile for USD-CNY. In early October,

for example, the 1Y USD-CNH forward stood at 6.4590, 4.3% above our revised

forecast for end-Q3 2012. Even as the CNH discount has dwindled, the USD-CNH

forward curve has become markedly upward-sloping (the 1Y forward pips are around

310 pips), supporting the USD bid in the forwards. Both the deliverable forward and

non-deliverable forward curves still significantly under-price prospective CNY gains

relative to our forecasts (see Chart 6), even after our revisions.

Non-deliverable USD-CNY and

deliverable USD-CNH forwards

significantly under-price

prospective CNY appreciation



Credit – Value in Dim Sum bonds

Changing currency dynamics have taken a toll on Dim Sum bonds

CNH volatility and widening credit spreads dampen enthusiasm

CNH bonds have underperformed counterparts in the USD space

CNH dislocations create relative-value opportunities

Returns trump volatility

Given all the recent market volatility, do Dim Sum bonds still offer value relative to

their USD counterparts?

Earlier this year, expectations of strong appreciation in both the onshore and offshore

Chinese yuan (CNY), coupled with ample liquidity, drove large inflows to Dim Sum

bonds. As a consequence, year-to-date Dim Sum issuance crossed the CNH 175bn

(USD 26.9bn) mark, and the CNH deposit base had expanded to CNH 622bn as of

end-September (the latest date for which data is available). The total volume of CNH

bonds outstanding – at CNH 190bn – could be comfortably absorbed by the total

deposit base, as Chart 1 shows. Deposits typically earn a negligible interest rate of

around 0.5%, and Dim Sum bonds were therefore seen as offering better value.

But everything changed in early September 2011, when the sharp global market sell-

off adversely impacted the CNH market, causing liquidity to flee. As a result, even the

highest-rated issues from China‟s government are now quoted below par. Lower-

rated high-grade (HG) paper (including from non-Chinese international issuers) and

high-yield (HY) paper (primarily from Chinese property developers) has fallen

considerably more in price and percentage terms. This correction was driven by:

1. Increased global risk aversion with the worsening of the euro-area sovereign

debt situation

2. China-specific issues related to tighter liquidity, fears of bad bank loans, and a

property bubble (the latter led to particular stress on developers‟ credit)

1. Chart 1: CNH deposits dwarf CNH bonds outstanding

CNH deposits and bonds outstanding (CNH bn)


0

100

200

300

400

500

600

700

Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11

Demand and Savings Deposits Time Deposits Outstanding

Vijay Chander, +852 3983 8569

[email protected]

Shankar Narayanaswamy, +65 6596 8249

[email protected]



3. Sudden liquidity pressures in the CNH market, which caused the CNH exchange

rate to turn sharply lower and trade at a steep discount to the onshore rate (this

was an Asia-wide trend, but it also had a China flavour)

Here we divide the CNH market into three categories and examine the impact of

spread widening on specific CNH issues in the HG and HY spaces. We focus in

particular on issuers that have both USD-denominated and CNH-denominated bond

issues with comparable tenors.

International issuers such as McDonald‟s, Volkswagen, Air Liquide. We believe

that CNH bonds offer value compared with the USD, either outright or on a

swapped basis (in some cases).

Local HG and quasi-sovereign names. CNH used to be expensive compared to

USD bonds (both on an unhedged and a swapped basis), but recent volatility in

spot CNH has resulted in a narrowing of the differentials on an outright

unhedged basis. That said, in general, USD bonds are still marginally cheaper.

In addition, the USD-CNH swap curve is now flattish to slightly upward-sloping

rather than inverted. Thus, on a swapped basis as well, USD bonds are now

cheaper than asset-swapped issues, since the yield pick-up on the swapped

paper has been reduced considerably.

Local HY, including the Chinese property sector. CNH bonds look expensive

given the much higher volatility in the USD space (especially in Chinese

property-sector credits), while the CNH space has been less volatile.

As a result, we argue that:

1. Among international issuers, investors should look at the MCD 13 in CNH, which

has widened quite substantially, while the MCD 13 in USD has been far less

volatile. As a result, the MCD in USD trades well inside the MCD Dim Sum bond.

2. In the HG space, the RESOUR 15 in USD clearly offers value compared to the

RESOUR 15 in CNH, both on an outright and an asset-swapped basis.

3. In the HY space, there has been a marked narrowing of spreads between the

CNH and equivalent USD issues from SHASHU and PWRLNG. USD paper from

SHASHU (but not PWRLNG) is still a touch wider in absolute yield terms.

Given our house view of further CNY gains over the next 12 months and the fact that

the CNH discount to CNY no longer exists (CNH and CNY have converged), we

expect CNH credits to resume their rally once markets stabilise, and to outperform

USD credits. On a positive note, there are tentative signs that the CNH currency

market is stabilising; as a consequence, credit spreads have tightened marginally

from their widest levels.

Overall market performance

Looking at total returns in aggregate, the benchmark HSBC Renminbi Total Return

Index is up 1.38% YTD in USD terms (as of 3 November, the last day for which data

for this index is publicly available). Returns from currency appreciation have totalled

2.973% since the beginning of the year (based on the end-2010 CNH exchange rate

of 6.58, versus the rate of 6.39 as of 3 November). The carry accruing from the

current average coupon on the index (2.72%) has totalled 2.288% YTD. Adverse

price movements in the individual credits that comprise the index account for the rest

of the move. With currency appreciation and total carry together accounting for

+5.008% of the move, losses on account of adverse price/credit movements have

While CNH returns have been

positive, this has been mostly

attributable to a combination of

positive carry and currency

appreciation



totalled 3.628% (given that total returns are only 1.38%). Clearly, the credit

component of the index has detracted from total returns.

Impact of the FX move

We expect the onshore CNY to appreciate further to 6.33 by year-end, up marginally

from current levels. We also expect the offshore CNH to rally marginally, to 6.34 by

end-2011 and 6.115 by end-2012. Thus, for investors with a time horizon out to

December 2012, returns from currency appreciation alone should contribute around

3.92% to total returns for the period. This is in contrast to the recent past, when

negative currency returns in the wake of offshore CNH volatility detracted from total

returns. With another 33.5bps of carry (at the index level) from 16 November through

year-end, plus a further 2.72% of carry in 2012, carry should contribute another 3.055%

to total returns through end-2012. Given our outlook for credit markets after the

recent widening, even assuming a relatively modest 50bps contraction in spreads

through end-2012, returns from spread compression should contribute 1.65% to total

returns between now and then (given the average portfolio duration of 2.93 years).

Thus, we expect a total index return of around 8.63% through end-2012. Favourable

selection of securities is likely to result in an even better performance.

The CNY has been appreciating at a steady pace of 5-6% a year versus the USD, as

Chart 2 shows. However, both the USD-CNH deliverable forwards and the NDFs (out

to 12M) have tended to underestimate the pace of CNY appreciation – they have

projected an appreciation range of 4.1-4.7%, while the actual pace of appreciation

has been somewhat faster. Our forecasts also project faster CNY appreciation than

is priced into the forwards over a period of one to two years.

In another interesting development, the USD-CNH swap curve, which used to be

downward-sloping (like the USD-CNY onshore curve, which is not accessible to

offshore investors), has changed shape and now trades quite flat (Chart 3). The

move in the USD-CNY NDF curve has been even more extreme, and it is now

modestly upward-sloping except at the shortest tenors. As a result, the yield pick-up

that investors would have previously received for swapping from CNH to USD has

not only disappeared but has turned negative. Changing expectations of CNH

appreciation and the recent market turmoil have contributed to this development.

Chart 2: CNY is appreciating at a steady pace

Annualised CNY appreciation (%) vs. actual CNY level

Chart 3: Impact of the swap curve

Both the CNH and USD-CNY NDF CCS curves are flat

Source: Standard Chartered Research Sources: Bloomberg, Standard Chartered Research

USD-CNY

Annualised App. - RHS

5% Top

6% Bottom

0%

2%

4%

6%

8%

10%

6.3

6.4

6.5

6.6

6.7

6.8

6.9

Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11

USD-CNH

USD-CNY NDF

USD-CNY Onshore

6.31

6.33

6.35

6.37

6.39

6.41

0.00 0.50 1.00Years forward



Nonetheless, despite the recent volatility, we believe that the Dim Sum bond market

remains a viable avenue for investors looking to enhance returns. We see the recent

price correction and the emergence of „two-way‟ interest in the market as a healthy

development. In addition, varying performance across rating categories suggests that

investors will need to conduct more diligent credit analysis. This is also a positive

development. While liquidity is down considerably from its peak levels in the March-

June 2011 period, when daily turnover averaged CNH 500mn, current daily volumes

of around CNH 150-200mn are still above the low point of CNH 50mn seen at the

height of the spread widening in September 2011.

Looking at the different categories in greater detail

We have broadly divided individual issuers in the Dim Sum bond market into three

categories: (1) multinational issuers that have issued bonds in the CNH market, (2)

HG issuers rated in the single-A to BBB category (excluding the highly rated China

sovereign but including quasi-sovereign issuers), and (3) sub-investment-grade

issuers rated in the BB to single-B range. We have looked at representative names

for the purpose of this exercise; other bonds in these categories may have moved

differently. Also note that there are a number of unrated issuers, as only about 40%

of CNH bond issuance has been rated. These would fall into one of the three

categories based on their overall credit ratings or their perceived credit profile, which

would place them in either the HG or HY category.

HG multinational issuers

In the multinational space (CNH and USD paper), the specific issues we considered

were the MCD 13 in CNH and USD and the Russian financial issue VTB 13 (CNH)

and VTB 15 (USD). All of them have seen a marked tightening of USD spreads

versus the comparable CNH bond issues. The clearest example of this is MCD,

where the CNH paper currently yields 2.04%, while the USD bonds of similar maturity

yield just 0.33%. In fact, McDonald‟s is one of the few credits where the USD bonds

have almost always traded tighter than the CNH bonds on a swapped basis. While

McDonald‟s is regarded as one of the safest credits in the US, and its USD bonds

have traditionally traded tight, the differential with the CNH bonds is currently at its

widest. As recently as May 2011, the differential between the USD and CNH paper

was flat to marginally negative (i.e., the CNH bonds briefly traded inside the USD

issue; see Chart 4).

Chart 4: MCD CNH trades cheap to the USD bonds

McDonald’s CNH 13 & CNH 13 (ASW) vs. USD 13 yield (%)

Chart 5: VTB CNH and USD issues converge

VTB CNH 13 & CNH 13 (ASW) vs. USD 15 yield (%)


CNH minus USD

MCD 13 (CNH)

MCD 13 (USD)

CNH asset-swapped

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

Jan-11 Mar-11 May-11 Jul-11 Sep-11

CNH minus USD

VTB 13 (CNH)

VTB 15 (USD)CNH asset-

swapped

-4

-2

0

2

4

6

8

Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11

Following the recent correction, the

mid-range of HG issues offers the

best value for investors, in our view

The development of a two-way bond

market in the Dim Sum bond space

is healthy and bodes well for the

future



In contrast, the VTB USD bonds traded 334bps wider than their CNH counterparts as

recently as early October. The differential has since collapsed to the point where the

VTB 13 Dim Sum bonds are trading flat to marginally inside the USD bonds – the first

time this has happened (see Chart 5). Nevertheless, given high volatility in VTB

paper generally, investors should wait for better entry points once volatility subsides

before buying these bonds.

Local HG issuers

In the local HG space, both the RESOUR 15 and HKCGAS 16 CNH-denominated

bonds have seen the differentials with their USD-denominated counterparts narrow to

their tightest-ever levels. Even so, USD yields are still higher in absolute terms than

yields on the CNH bonds (Charts 6 and 7). Here again, the narrowing in absolute

terms has been partly offset by the fact that the USD CNH cross-currency swap

(CCS) curve has changed shape, so that the swapped yields for CNH bonds make

them less attractive than before. More interestingly, this CNH bond weakness has

occurred as the USD HG issues have rallied in both yield and price terms (due partly

to the strengthening of USTs as risk assets globally have weakened).

Chart 6: RESOUR 15 CNH bonds have cheapened

China Resources CNH 15 & CNH 15 (ASW) vs. USD 15 yield

(%)

Chart 7: HKCGAS USD & CNH differentials narrow

HKCGAS CNH 16 & CNH 16 (ASW) vs. USD 18 yield (%)


Chart 8: PWRLNG 14 CNH issue weakens

PWRLNG CNH 14 & CNH 14 (ASW) vs. USD 15 yield (%)

Chart 9: SHASHU 14 CNH issue less volatile than USD

SHASHU CNH 14 & CNH 14 (ASW) vs. USD 16 yield (%)


CNH minus USD

RESOUR 15

RESOUR 15 (USD)

CNH Asset Swapped

-3

-2

-1

0

1

2

3

4

5

6

Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11

CNH minus USD

HKCGAS 16 (CNH)

HKCGAS 18 (USD)

CNH asset-swapped

-4

-3

-2

-1

0

1

2

3

4

5

Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11

CNH minus USD (RHS)

PWRLNG 14 (CNH)

PWRLNG 15 (USD)CNH asset-

swapped

-4

-2

0

2

4

6

0

10

20

30

40

Mar-11 May-11 Jul-11 Sep-11 Nov-11

CNH minus USD (RHS)

SHASHU 14 (CNH)

SHASHU 16 (USD)

CNH asset-swapped

-10

-8

-6

-4

-2

0

0

4

8

12

16

20

Jul-11 Aug-11 Sep-11 Oct-11



Local HY issuers

Unlike in the HG space, the USD- and CNH-denominated bonds of the two HY

issuers we considered – PWRLNG (Powerlong) in the property space and SHASHU

(China Shanshui) in the industrials space – have fallen in price terms, although they

have recovered some lost ground relative to their worst levels. In the case of

Powerlong, the fall was quite sharp (Charts 8 and 9). Negative perceptions of the

Chinese HY sector have driven the overall weakness in this sector. These have been

driven by both micro issues (including accounting and transparency concerns about

Chinese corporates and property-sector weakness) and macro issues related to fears

of a sharp economic slowdown in China. Even for these HY bonds, the Dim Sum

bonds have clearly underperformed their USD counterparts. This has been

particularly pronounced in the case of PWRLNG, to the extent that the CNH bonds

now trade wider than the USD bonds (the opposite situation prevailed previously).

Under the circumstances, investors willing to take PWRLNG risk might want to

consider putting it on via CNH rather than USD, although the differences in yield are

not material. It is also worth highlighting that liquidity is considerably higher in the

USD paper, so buying the CNH bonds might be a better choice for investors with a

„buy and hold‟ objective.



Economics – The meaning of micro-loosening

Monetary policy was tightened in Q3, but loosened a bit in November

CNH market disruption appears to have caused reversal of FX flows

Further loosening is on the cards

As gnomic utterances about monetary policy go, „weitiao‟ („micro-adjustment‟) is up

there with the best. Premier Wen Jiabao spoke three weeks ago about how China‟s

“prudent” monetary policy would be “micro-adjusted”. Facing an insolvent Ministry of

Railways (and thousands of unpaid rail workers) and an SME funding crisis of

unclear proportions the authorities were clearly pressure to do something to loosen

monetary policy.

But so far, that something has had a limited impact on business conditions on the

ground. Lending growth has stopped decelerating, but that is about it. The People‟s

Bank of China (PBoC) continues to believe that China‟s domestic economy is doing

OK and that its policy stance is not overly tight. Despite Europe‟s existential crisis,

China‟s economic leadership team is still more or less supporting this line. In this

section, we quickly run through just how „prudent‟ monetary policy became in Q3,

how the „micro-adjustment‟ is going, and where monetary conditions are likely to go

in the run-up to Chinese New Year in January 2012.

A tough time to borrow

De facto lending rates rose almost 80bps in Q3 – the weighted average one-year

loan rate moved to 8.06% from 7.29% in Q2, as Chart 1 shows (banks can lend at

any rate above the benchmark rate, which is currently at 6.56% for one-year loans).

In other words, while the benchmark rate was hiked only once, corporate China was

hit with the equivalent of three 25bps hikes. The lending rate has not reached the

highs of H1-2008, but the premium to the benchmark rate is now 150bps, higher than

the 125bps premium recorded in the previous round of tightening in 2008. 67% of all

loans in the system were priced above PBoC benchmark rates in Q3, up from 61% in

Q2. This is a tough time to be a borrower.

Official loan growth in September was 15.9% y/y, 0.4ppt above the average from

2000-08, according to the PBoC‟s Q3 Monetary Policy Report. In other words, the

Chart 1: Rates are a lot higher in reality

1-year base and weighted average interest rate, %

Chart 2: Below-average loan growth

Loan growth, real, y/y %

Sources: CEIC, Standard Chartered Research Sources: CEIC, Standard Chartered Research

One-year weighted-average

lending rate

One-year base lending rate

5%

6%

7%

8%

9%

Jan-03 Jan-05 Jan-07 Jan-09 Jan-11

y/y % real

Average

0%

10%

20%

30%

40%

Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10


[email protected]

Actual lending rates rose

significantly in Q3



central bank suggests that monetary conditions are not really that tight. However,

inflation-adjusted loan growth is considerably slower – about 9% y/y at present – and

is running well below its historical average (see Chart 2). We also note that real loan

growth has just begun to tick up.

‘Total social financing’ has slowed too

With the development of other sources of credit, we also need to track non-loan

sources of finance. In Chart 3, we show the components of the PBoC‟s concept of

„total social financing‟ (TSF) as best we can. TSF extension has slowed markedly as a

result of changes to the regulation of products such as trust and entrustment loans.

There was a net contraction in bankers-accepted drafts (BAD) outstanding in Q3.

This presumably resulted from the PBoC‟s move to demand that reserves be paid on

the margin deposits required by the banks for issuing BADs (although there are

reports that the PBoC is going easy on the banks as far as enforcement of this rule is

concerned).

BADs can be used as payment for goods. Many firms finance their short-term trade

by discounting those BADs. Discounting rates for these bills are therefore critical, and

move independently of the PBoC‟s base rates. As Chart 7 shows, draft discounting

rates have fallen from their painful peak of 15% in late September, but were holding

at around 9% as of mid-October, which is still pretty expensive. We note that many

SMEs get their financing via this route – so for them, monetary conditions have

hardly eased. Further declines in the discount rate depend very much on the banks‟

ability to expand their total lending.

We also note the small reduction in trust loans in Q3, the result of a crackdown on

bank-trust products by the China Banking Regulatory Commission (CBRC). One of

the first public statements by new CBRC Chairman Shang Fulin was to remind banks

to move bank-trust loan products onto their balance sheets. This will not affect the

amount banks can lend, since such transfers do not count towards the loan quota,

but they do require provisions and capital to be held against the loans. A recent

article in the 21st Business Herald estimated that some CNY 1trn (USD 160bn) worth

of such loans are still held off-balance-sheet. Trusts have to raise capital against their

managed assets, and some types of products (e.g., real estate loans) are being

controlled.

(An aside: The TSF numbers released in the PBoC‟s reports this year do not appear to

add up. We spot an unexplained disparity of some CNY 400bn between the total

announced for the first three quarters of 2011 (CNY 9.8trn) and the sum of the

component parts announced each quarter during the period (CNY 9.486trn). A

consolidated table with the quarterly TSF numbers would be a welcome addition to the

Q4 report.)

Money multiplier is falling

China‟s fundamental monetary problem – fast exogenous money supply growth – is

still a clear and present danger. As Chart 6 shows, as a result of FX inflows, official

reserve money is still growing at 32% y/y. The PBoC managed to push down the

multiplier (the link between M2 and reserve money growth) to 3.71 in September,

near its 10-year low. However, the PBoC‟s definition of reserve money is

unconventional; we note that the pace of growth in the central bank‟s total liabilities is

considerably lower than reserve money growth, at only 15% y/y, which is better news.

Despite the rapid reserve money

build, the loan quota restrictions

have suppressed the money

multiplier, to near its 2008 low.

Many firms rely upon trade finance,

and rates – though down from the

peak – are still high



Current and capital accounts remain in surplus, but onshore CNY

selling

Exogenous money supply comes from China‟s twin external imbalances. The current

account was still in significant surplus in Q3, at USD 58bn (USD 146bn for the first

three quarters of 2011), moderately down from last year‟s level (see Chart 4).

In the capital account, net direct investment flows were USD 36bn in Q3 (USD 128bn

for Q1-Q3). The FX reserves build-up in Q3 was USD a still-substantial USD 92bn

(USD 373bn for Q1-Q3). Despite the weirdness of September, when the onshore CNY

traded above the ever-lower CNY daily fixings (more on this below), we believe the twin

surpluses suggest that the case for CNY undervaluation is still in place. 2012 is likely to

see continuing surpluses, albeit smaller. We therefore look for moderate CNY

appreciation in 2012, as laid out elsewhere in this publication.

In terms of the flow of funds, FX inflows were concentrated in July and August. These

inflows appear to have partly reversed in September and October; we believe this

was driven by the offshore CNH market. When USD-CNH is trading at a discount to

onshore USD-CNY (as in September-October), this encourages importers to buy

their dollars onshore, while exporters have a bigger incentive to sell their dollars

offshore. This is the opposite of the incentives that dominated up to September,

when USD-CNH traded at a premium to onshore USD-CNY. Thus, from Q1 to Q3,

net dollar selling onshore meant the PBoC had more dollars to buy, while in

September and October the PBoC had to supply more dollars. Because corporates

are involved in hedging forward their future exposures on and offshore, the FX flows

involved can be larger than the underlying goods trade in those months.

Chart 5 we show the apparent FX outflow that resulted from these dynamics –

September is reminiscent of late 2008, when CNY sentiment soured and hedging

driven by appreciation expectations reversed. The chart, derived from the FX reserve

numbers (adjusted for valuation effects) and the available monthly trade and direct

investment data, comes with a warning: the data is partial, and we do not know for

sure how the State Administration of Foreign Exchange (SAFE) now calculates the

FX reserves. It is possible that it marks its book to market at the end of each quarter.

The chart does show lots of unexplained FX inflows in Q1-Q3, followed by an

apparent reversal in September.

Chart 3: Total social financing is declining

CNY bn

Sources: CEIC, Standard Chartered Research

-500

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Q1 2010 Q2 2010 Q3 2010 Q1 2011 Q2 2011 Q3 2011

CNY loans FX loans Entrustment loansTrust loans Bankers accepted drafts Corporate bondsNon-financial shares

Trade and investment accounts still

have big surpluses, but outward

remittances appear to have picked

up

Apparent FX outflows explained, we

think, by shifting gap between CNH

and CNY FX rates.



Another indicator of net CNY selling is if the „Net purchases of FX‟ (外汇占款) number

turns negative, which it did to the tune of CNY 25bn (USD 4bn) in October. The last

time it did so was in January-February 2009. This number is usually positive,

reflecting net buying of dollars by commercial banks and the PBoC. The negative

number in October indicates that the corporate sector turned into a net seller of

CNY/net buyer of dollars, driven by the dynamics explained above, we believe. One

or two months of small FX „outflows‟ do not a China crisis make, so we advise some

caution before calling this another signal of China‟s imminent collapse. But the

numbers clearly bear watching.

So what now?

So far, Ministry of Railways (MoR) has benefitted the most from „micro-adjustment‟.

Banks were reportedly instructed to extend CNY 200-250bn in new loans to the MoR,

which already has CNY 2trn of outstanding debt and whose operations have negative

cash flow (see On the Ground, 26 July 26 2011, ‘China – The Ministry of

Railways’ many debts’). There are reports from Zhejiang that banks have extended

extra funds to SMEs, and that this liquidity is outside of the loan quota. Otherwise,

though, money remains pretty tight, especially for SMEs: the discounting rate

remains elevated (Chart 7).

We expect loan CNY growth of around CNY 8.5trn in 2012 (up 15% y/y), and expect

monthly lending to exceed CNY 600-650bn in November and December 2011. The

official loan quota for 2012 will probably come in below this number, at around CNY

7.5-8.0trn, on the basis that with a GDP growth target of 8% and CPI inflation target

of 4%, lending growth should be targeted at 12-14%.

However, our inflation outlook for 2012 is benign, the informal financial sector is

already deleveraging (recall the decline in trust lending), and policy makers will

increasingly want to boost growth from Q2-2012 onwards (see On the Ground, 25

October 2011, ‘China – Forecast revisions, 2012-13’). Local government

investment vehicles will need financing, and the banks are still the main source (as

Chart 3 shows, bond issuance is still small, but it could be boosted). The PBoC‟s

ability to control banks through the quota will be limited.

Chart 4: Current account is smaller, but still big

USD bn

Chart 5: Apparent FX outflows in September

USD bn


-20

0

20

40

60

80

100

120

Q1 2010 Q3 2010 Q1 2011 Q3 2011

Transfers Income Trade

-80

-60

-40

-20

0

20

40

60

80

100

Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11

Trade (BoP) Net FDI (BoP)

Returns on investment Everything else

Micro-loosening has benefitted the

Ministry of Railways and some

Zhejiang SMEs. But trade financing

is still expensive.



As far as interbank rates go, there are volatile times ahead in the run up to Chinese

New Year (Jan 23). Fiscal funds will be injected into the system (On the Ground,

November 10, 2011, ‘China – Fantastical fiscal fireworks’). But at the same time,

there is little PBoC bill redemption and with Chinese New Year so soon in January,

corporates may be hoarding cash early. We believe a cut in the reserve requirement

ratio (RRR) is likely before Chinese New Year – but in the run-up to that interbank

interest rates are likely to be volatile and lack a clear direction. After the CNY holiday,

we see inter-bank rates lower.

Chart 6: Strong reserve growth, a suppressed multiplier

Money multiplier (x) and reserve money growth (%)

Chart 7: Off the highs, but not low

Weighted average bill discount rate, %


Money multiplier

Reserve money, y/y %

(RHS)

0%

10%

20%

30%

40%

50%

60%

3.0

3.5

4.0

4.5

5.0

5.5

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

0

2

4

6

8

10

12

14

16

18

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

Interbank rates will be volatile in the

run up to Chinese New Year (Jan

23), but after that should be lower.



Appendix

The CNH timeline

2003-2007

December 2003: The HKMA announced the beginning of CNY business on a trial basis in Hong Kong.

Initial development of the offshore market was extremely limited, basically confined to the build-up of CNY

in low-yielding retail bank deposits and the provision of restricted personal CNY services.

June 2007: The PBoC and National Development and Reform Commission (NDRC) announced that

financial entities incorporated in China were allowed to issue CNY bonds in Hong Kong, subject to

approval. This was the first step towards creating more uses for CNY funds in Hong Kong.

December 2008: China signed its first bilateral currency swap arrangement with South Korea. Shortly

after, the PBoC and the HKMA signed a currency swap agreement to provide CNY liquidity of up to CNY

200bn for a renewable three-year term. The number of swap participants has since increased to eight

counterparties.

June 2009: The PBoC launched the pilot scheme for CNY settlement of cross-border trade between

Shanghai and four cities in Guangdong province on the one hand, and Hong Kong and Macau on the

other. This scheme allowed CNY conversion within selected cities between the onshore and offshore

markets for trade-related transactions.

September 2009: China‟s Ministry of Finance launched two tranches of CNY bonds (CNY 6bn in total) to

retail and institutional investors in Hong Kong. This was the first CNY-denominated sovereign offering

outside of the mainland.

2008-2009

2010

February 2010: The HKMA issued a clarification that participating banks could develop CNY business

based on regulatory requirements and market conditions in Hong Kong, as long as these businesses do

not entail the flow of CNY funds back to the mainland.

June 2010: Six regulatory bodies in China released a joint circular, expanding the scope of the CNY

trade settlement pilot scheme to 20 mainland provinces on the one hand, and all overseas countries and

regions on the other.

July 2010: The PBoC and the HKMA signed a Supplementary Memorandum of Co-operation, which

broadened the scope of CNY holders to all corporates and differentiated between treatment of their trade-

and non-trade-related CNY conversions. Subsequently, the development of CNY financial products also

picked up.

August 2010: The PBoC announced that foreign central banks, CNY clearing banks, and cross-border

CNY trade-settlement-participating banks could take part in the interbank bond market in mainland China.

This is subject to a quota system, with specific limits to be approved by the PBoC.

August 2010: Standard Chartered Bank managed a CNY 200mn bond issuance for McDonald‟s

Corporation. This was the first issuance of a CNY-denominated bond by an overseas non-financial

corporation outside the mainland. This signified the emergence of a new funding channel for international

companies to raise working capital for their China operations.

October and December 2010: The depletion in late October of the trade-related conversion quota

granted to the clearing bank led to a revamp of the arrangement in December. Refinements included an

expanded quota and measures to discourage offshore CNY hoarding and speculation. Separately, the

PBoC expanded the list of Mainland Designated Enterprises in December.



January 2011: The PBoC launched a pilot scheme for the settlement of overseas direct investments in

CNY (CNH ODI). Under the scheme, Hong Kong branches and correspondent banks of mainland banks

can obtain CNY funds from the mainland and finance these investments.

January 2011: The first CNY synthetic (straight) bond was issued in Hong Kong.

March 2011: The HKEx announced plans for the H2-2011 roll-out of the „RMB Equity Trading Support

Facility‟ (TSF) – back-up liquidity to facilitate the trading of CNH equities in the secondary market.

March 2011: The launch of the Fiduciary Account arrangement was announced (effective in April) to help

banks better manage their credit exposure to the clearing bank when using their CNY funds. The interest

rate paid by the PBoC to the clearing bank was cut to 0.72% from 0.99%. The clearing bank and most

banks in Hong Kong subsequently lowered their CNY deposit rates accordingly.

April 2011: The first CNH IPO was launched in Hong Kong.

June 2011: The PBoC announced a number of policy fine-tuning steps on 8 June, including the

alignment of treatment of trade-related FX conversion by participating banks with onshore agent banks

and with the clearing bank. For services trade settlement, FX conversion offshore can only enjoy the

offshore CNY (CNH) rate. Separately, the spot USD-CNH fixing was officially launched on 27 June.

July 2011: PBoC announced that it would stop handling new applications from onshore corporates for

cross-border CNY loans by offshore banks (shareholder loans and trade financing were not affected).

Separately, the HKMA relaxed treatment of CNH FX swaps under the 10% NOP rule.

August 2011: China Vice Premier Li Keqiang visited Hong Kong and announced more than 30

concessions, including CNH FDI, R-QFII, and an explicit commitment to broadening and deepening

existing CNH markets. MOFCOM announced a consultation on new CNH FDI rules. The CNY trade

settlement scheme was officially expanded to the whole of China. The Ministry of Finance issued CNY

20bn worth of CNH bonds. The HKMA required banks to include lending in all currencies via CNY L/C

discounting in their NOP calculations.

September 2011: Global risk aversion caused CNH to weaken, leading to the exhaustion of the CNH

trade settlement conversion quota for Q3-2011. With the quota exhausted, CNH weakened further.

October 2011: The trade conversion quota was renewed and expanded for Q4. New CNH foreign direct

investment rules were formalised by MOFCOM and the PBoC.

November 2011: The HKMA issued a circular that clarified the eligibility criteria for firms tapping the trade

conversion quota and increased documentation requirements.

2011



Dim Sum bond run

CNH government bonds

Issuer Sector Issue date Size

(CNY mn) Coupon Maturity Tenor

Indicative bid yield (%)

MoF CGB Sovereign 27-Oct-2009 2,500 2.70 27-Oct-2012 1 1.20

MoF CGB Sovereign 20-Dec-2010 3,000 1.60 20-Dec-2012 1 1.20

MoF CGB Sovereign 06-Sep-2011 5,000 1.60 06-Sep-2013 2 1.25


MoF CGB Sovereign 18-Aug-2011 6,000 0.60 18-Aug-2014 3 1.60

MoF CGB Sovereign 27-Oct-2009 500 3.30 27-Oct-2014 3 1.70






Policy bank bonds




China Development Bank Policy bank 11-Nov-2010 3,000 2.70 11-Nov-2013 2 2.40

CNH FI bank bonds




Bank of Communications FI bank 04-Mar-2011 1,000 1.00 04-Mar-2013 2 2.70

Far East Horizon Ltd. FI bank 03-Jun-2011 1,250 3.90 03-Jun-2014 3 7.18

ICBC (Asia) FI bank 24-Sep-2010 1,000 2.25 24-Sep-2012 1 1.90

UA Finance BVI Ltd. FI bank 28-Apr-2011 500 4.00 11-Nov-2013 2 13.97

VTB Capital SA FI bank 23-Dec-2010 1,000 2.95 28-Apr-2014 3 4.70

CNH multinational bonds




Air Liquide Finance Multinational 19-Sep-2011 1,750 3.00 19-Sep-2016 5 3.17

BP Capital Markets Plc Multinational 14-Sep-2011 700 1.70 15-Sep-2014 3 2.35

Caterpillar Financial Services Multinational 01-Dec-2010 1,000 2.00 01-Dec-2012 1 2.00

Caterpillar Financial Services Multinational 12-Jul-2011 2,300 1.35 12-Jul-2013 2 2.29

McDonald's Corporation Multinational 16-Sep-2010 200 3.00 16-Sep-2013 2 1.95

Tesco PLC Multinational 01-Sep-2011 725 1.75 01-Sep-2014 3 2.12

Volkswagen AG Multinational 23-May-2011 1,500 2.15 23-May-2016 5 2.99




CNH corporate bonds




Beijing Enterprise Water Corporate 30-Jun-11 1,000 3.75 30-Jun-14 3 3.75

Beijing Enterprise Water Corporate 30-Jun-11 450 5 30-Jun-16 5 4.94

Big Will Investments (Guangzhou R&F Properties)

Corporate 29-Apr-11 2,612 7 29-Apr-14 3 21.19

BYD HK Co. Ltd. Corporate 28-Apr-11 1,000 4.5 28-Apr-14 3 16.93

China Merchants Holdings (Hong Kong) Corporate 19-Nov-10 700 2.9 19-Nov-13 2 2.71

China Power International Corporate 23-Dec-10 800 3.2 23-Dec-15 4 4.83

China Power New Energy Corporate 29-Apr-11 500 3.75 29-Apr-14 3 6.45

China Resources Power Corporate 12-Nov-10 1,000 2.9 12-Nov-13 2 2.9

China Shanshui Cement Group Ltd. Corporate 22-Jul-11 1,500 6.5 22-Jul-14 3 9.53

CNPC Golden Autumn Limited Corporate 19-Oct-11 2,500 2.55 26-Oct-13 2 2.68

CNPC Golden Autumn Limited Corporate 19-Oct-11 500 2.95 26-Oct-14 3 2.28

Eastern Air Overseas HK Corporate 8-Aug-11 2,500 4 8-Aug-14 3 4

Global Logistics Properties Corporate 11-May-11 2,650 3.38 11-May-16 5 3.87

Hai Chao Trading Co. Ltd. Corporate 4-Aug-11 900 2 4-Aug-14 3 3.17

Hainan Airline HK Corporate 16-Sep-11 1,000 6 16-Sep-14 3 8.12

HKCG Finance Ltd./Towngas Corporate 11-Apr-11 1,000 1.4 11-Apr-16 5 2.99

Intime Department Store Corporate 19-Jul-11 1,000 4.65 21-Jul-14 3 7.59

Lafarge Shui On Cement Corporate 9-Nov-11 1,500 9 14-Nov-14 3 8.52

Pacific Andres Res Dev Corporate 2-Jun-11 600 6.5 2-Jun-14 3 15.91

Right Century Corporate 3-Jun-11 3,000 1.85 3-Jun-14 3 3.41

Road King Infrastructure Ltd. Corporate 25-Feb-11 1,300 6 25-Feb-14 3 16.38

Sinochem Hong Kong Group Ltd. Corporate 18-Jan-11 3,500 1.8 18-Jan-14 3 3.62

Zhongsheng Group Corporate 21-Apr-11 1,250 4.75 21-Apr-14 3 11.02

CNH synthetic bonds




Evergrande Real Estate Group Corporate 19-Jan-2011 3,700 7.50 19-Jan-2014 3 19.90

Evergrande Real Estate Group Corporate 19-Jan-2011 5,550 9.25 19-Jan-2016 5 21.06

Powerlong Real Estate HL Corporate 17-Mar-2011 750 11.50 17-Mar-2014 3 30.37

Shui On Land Corporate 23-Dec-2010 3,000 6.88 23-Dec-2013 2 8.47

Shui On Land Corporate 26-Jan-2011 3,500 7.63 26-Jan-2015 4 9.28



Product update – Latest CNH products available in Hong Kong

CNH product Availability Remarks

Spot Yes Daily CNH interbank liquidity of USD 1.5bn, compared to USD 10-15bn onshore.

Forward Yes There are now CNY DF (onshore), CNY NDF (offshore) and CNH DF curves (offshore).

FRA/CCS Yes for CCS There is no FRA CNH. Daily CCS turnover has increased sharply recently to USD 150-200mn in the 1-3Y; longer tenors are less liquid.

Money market Yes Interbank trading is relatively thin amid CNH „pooling‟ at a small number of institutions. Daily interbank CNH lending around CNH 1bn in recent weeks.

CDs/structured notes Yes for CDs CDs launched; structured notes may be seen soon.

IRS Yes The CNH 3M SHIBOR IRS is still pretty illiquid, with daily turnover of CNH 0-100mn. The CNY NDIRS (USD) has daily liquidity of around CNY 1bn.

Structured products Not all Fully funded structures so far.

Bonds Yes Growing number of both regular and synthetic issues; daily turnover is steady at CNH 200mn.

Source: Standard Chartered Research



Key China views and projections

Central bank outlook

Current To end-2011 Next Forecast next change Last change

Benchmark rate (%) (bps) meeting Date Action Date Action

China 1Y lending rate 6.56 0 NA Q1-2013 +25bps 06-Jul-11 +25bps

FICC-on-the-run

Spot 3M 3-12M Fundamentals Current trades

CNY 6.36 ↑ ↑ CNY gains to curb inflation as risk appetite and fundamentals stabilise -

10Y bond 3-6M 6M+ Fundamentals Current trades

China 3.93 ↓ ↑ Growth and inflation to slow down before rebounding in H2-2012 -

Forecasts – Economic

Real GDP growth (%) Inflation (yearly average %) Current account (% of GDP)

2010 2011 2012 2013 2010 2011 2012 2013 2010 2011 2012 2013

China 10.3 9.2 8.5 8.5 3.3 5.1 3.2 5.4 5.5 3.6 2.3 2.1

Forecasts – FX

End-period Period average

2011 2012 2013 2012 2013 2014 2015 2016

Q4 Q1 Q2 Q3 Q4 Q1

USD-CNY 6.32 6.28 6.24 6.18 6.12 6.07 6.23 6.00 5.85 5.65 5.45

forward 6.36 6.35 6.34 6.34 6.34 6.33

USD-CNH 6.33 6.265 6.225 6.165 6.105 6.055

Forecasts – China rates

End-period Period average

2011 2012 2012 2013 2014 2015 2016

Q4 Q1 Q2 Q3 Q4

Policy rate

1Y lending rate 6.56 6.56 6.56 6.56 6.56 6.56 7.31 (YE)

Bonds

2Y 3.50 3.40 3.60 3.80 4.00 3.70 3.80 3.60 3.30 3.30

10Y 3.60 3.80 4.00 4.20 4.30 4.00 4.50 4.40 4.30 4.30

Swaps

7-day repo 2.50 2.50 2.50 3.00 3.50 3.90 4.00 4.00 4.00 4.00

2Y 3.50 3.70 3.90 4.10 4.15 4.00 4.20 4.20 4.20 4.20

10Y 3.40 3.80 4.10 4.30 4.40 4.20 4.50 4.50 4.40 4.40

CNH market

2011

Jan Feb Mar Apr May Jun Jul Aug Sep

Remittances for RMB cross-border trade settlement (CNY bn)

Hong Kong 108 87.4 115.4 134.2 153.4 205.1 149 185.8 190.6

Jan - Mar 2011 Apr - Jun 2011 Jul - Sep 2011

China 360.3 597.3 583.4

Sources: HKMA, PBoC, Standard Chartered Research



Key China views and projections (continued)

Chart 1: CNH deposit growth (CNY bn)

End-September CNH deposits: CNY 622.2bn

Chart 2: Our estimates of daily market turnover (USD mn)

End-October daily turnover in CNH spot: USD 1.5bn

Sources: HKMA, Standard Chartered Research Sources: Standard Chartered Research

Chart 3: China’s projected annual total CNY trade

settlement volume (USD bn)

Chart 4: China’s projected annual import value of goods

by settlement currency (USD bn)

Sources: PBoC, Standard Chartered Research Sources: PBoC, Standard Chartered Research

Time deposits

End 2011 Forecast

End 2012 Forecast

0

200

400

600

800

1,000

Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Dec-11

Demand and savings deposits

0

500

1,000

1,500

2,000

2,500

3,000

Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11

CNH swap

CNH spot

77

310

475

690

920

1,220

0

400

800

1,200

1,600

2009 - 2010 2011 2012 2013 2014 2015

188 270 371 472 593

1,5281,668

1,8192,003

2,204

0

1,000

2,000

3,000

2011 2012 2013 2014 2015

Imports settled in other currencies

Imports settled in CNY

Chart 5: Issuance of Dim Sum bonds since 2007 (CNY bn) Chart 6: Trade-weighted value of the CNY (CNY NEER) is

now above its June 2010 post-de-peg level

Sources: Bloomberg, Standard Chartered Research Sources: BIS, Standard Chartered Research

0

20

40

60

80

100

120

140

160

180

2007 2008 2009 2010 2011 YTD

BIS CNY NEER -Monthly

CNY NEER -Our Daily Estimate

105

110

115

120

Jul-09 Jan-10 Jul-10 Jan-11 Jul-11



Disclosures Appendix

Recommendations structure

Standard Chartered terminology Impact Definition

Issuer – Credit outlook

Positive Improve We expect the fundamental credit profile of the

issuer to <Impact> over the next 12 months Stable Remain stable

Negative Deteriorate

Apart from trade ideas described below, Standard Chartered Research no longer offers specific bond and CDS recommendations.

Any previously-offered recommendations on instruments are withdrawn forthwith and should not be relied upon.

Standard Chartered Research offers trade ideas with outright Buy or Sell recommendations on bonds as well as pair trade recommendations

among bonds and/or CDS. In Trading Recommendations/Ideas/Notes, the time horizon is dependent on prevailing market conditions and may

or may not include price targets.

Credit trend distribution (as at 16 November 2011)

Coverage total (IB%)

Positive 15 (6.7%)

Stable 180 (17.2%)

Negative 28 (17.9%)

Total (IB%) 223 (16.6%)

Credit trend history (past 12 months)

Company Date Credit outlook

Please see the individual company reports for other credit trend history

Regulatory Disclosure: Subject companies: Air Liquide, Air Liquide Finance, Bank of Communications, Beijing Enterprise Water, Big Will Investments (Guangzhou R&F Properties), BP Capital Markets

PLC, BYD HK Co. Ltd., Caterpillar Financial Services, China Development Bank, China Merchants Holdings (HK), China Power International, China Power New Energy, China

Resources, China Resources Power, China Sanshui Cement, China Shanshui Cement Group Ltd., CNPC Golden Autumn Limited, Eastern Air Overseas HK, Evergrande Real

Estate Group, Far East Horizon Ltd., Global Logistics Properties, Hai Chao Trading Co. Ltd., Hainan Airline HK, HK & China Gas, HKCG Finance Ltd./Towngas, ICBC (Asia), Intime

Department Store, Lafarge Shui On Cement, McDonalds, McDonalds Corporation, Pacific Andes Resources Development, Powerlong Real Estate HL, Right Century, Road King

Infrastructure Ltd., Shui On Land, Sinochem Hong Kong Group Ltd., Tesco PLC, The Ministry of Finance (China Government/sovereign), UA Finance BVI Ltd., Volkswagen,

Volkswagen AG, VTB Capital SA, VTB Capital SA, Zhongsheng Group

Standard Chartered Bank and/or its affiliates have received compensation for the provision of investment banking or financial advisory services within the past one

year: -



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Document approved by

Stephen Green

Regional Head of Research, Greater China

Data available as of

09:00 GMT 21 November 2011

Document is released at

09:00 GMT 21 November 2011

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