Impact of RRR increase likely to be limited on onshore market

The People's Bank of China announced on Monday that effective Jan 25, offshore renminbi deposits (CNH) that were deposited with onshore representative banks (excluding CNH held by foreign central banks, sovereign wealth funds and international financial institutions) would be subject to the same reserve requirements as other onshore renminbi deposits.

Motivation behind the move is largely offshore focused. Officially a RRR on offshore renminbi balance has been in place since December 2014, but had attracted little notice before as it been kept at zero until now.

At the time the PBOC had said the RRR would eventually be raised to normal levels in future. The timing of this announcement can be interpreted as an attempt by the central bank to bring offshore market liquidity more under the control of its liquidity management framework, as like the PBOC's ongoing tightening of onshore/offshore capital flow controls. The move effectively further tightens offshore CNH liquidity, pushing up the cost of onshore/offshore arbitrage activity.

The new rule affects CNH deposits held by offshore renminbi clearing or participating banks with onshore deposits, including for example: 1) foreign participating banks renminbi with onshore clearing banks; 2) BOC (HK), BOC (Macao) renminbi cash with PBC (Shenzhen or Zhuhai branches); 3) other offshore clearing banks renminbi with their onshore headquarters. It has yet to be clarified how participating banks with cash parked with offshore clearing bank will be treated.

We believe any impact on onshore money market rates or liquidity would likely be limited, given the extremely small scale of offshore market flows versus onshore market liquidity (e.g. Hong Kong has less than renminbi 900 billion in CNH deposits versus onshore renminbi deposits of renminbi 136 trillion).

The impact of the RRR raise on offshore liquidity will likely be negative but is difficult to quantify as it depends on how much liquidity offshore clearing banks put back to onshore on a daily basis (also unclear how much of that belongs to foreign central banks/sovereign wealth funds).

CNH trading opened sharply higher but steadily offered down by local names. Although we do not believe the move is directly targeted at offshore funding rate, the impact could still be a much tighter funding situation due to fear factor.

The article is written in collaboration with Donna Kwok and Ning Zhang - all three are UBS economists. The views do not necessarily reflect those of China Daily.