l Global Research l

Important disclosures can be found in the Disclosures Appendix
All rights reserved. Standard Chartered Bank 2012 research.standardchartered.com
Contents
Focus – Loosening, but steady does it 2
CNH market – Shifting sands, expanding universe 7
FX – USD-CNH repricing on higher CNH returns 13
Credit – Dim Sum bonds – A maturing market 17
Economics – Angels, demons and investment
proxies 21
Appendix 25
CNH premium to onshore CNY

Sources: Bloomberg, Standard Chartered Research

-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
Jan-11 Apr-11 Jul-11 Oct-11 Jan-12
Key strategies
Now Target Stop-loss
Credit
Buy CNPCCH 2.55% 13 100.25 101.00 99.25
FX
Long USD in 6M
USD-CNY NDF
6.2893 6.40 6.20
Long 1Y USD-CNH put spread (ATMF and 22-delta strikes)

Eddie Cheung, +852 3983 8566
Eddie.Cheung@sc.com
Kelvin Lau, +852 3983 8565
Kelvin.KH.Lau@sc.com
Lan Shen, +86 21 6168 5019
Lan.Shen@sc.com
Robert Minikin, +852 3983 8567
Robert.Minikin@sc.com
Sandeep Tharian, +44 20 7885 5171
Sandeep.Tharian@sc.com
Stephen Green, +852 3983 8556
Stephen.Green@sc.com
Wei Li, +86 21 6168 5017
Li.Wei@sc.com


The Renminbi Insider | 06:30 GMT 15 February 2012
Growing up




Highlights
 China‟s economy is still slowing, and policy makers are signalling an increasing
willingness to loosen policy. We have already seen marginal improvements, such
as the steady fall in the draft discount borrowing rate and the upturn in (real)
credit growth. Small moves to support the real-estate market are also happening.
We continue to look for five reserve requirement cuts in 2012, but no interest rate
cuts. Growth in Q1 will be weak, but a mild U-shaped recovery is likely to begin in
mid-Q2.
 The return of the CNH premium will rekindle CNH deposit growth in Hong Kong in
2012. Tighter CNH liquidity, which has pushed up deposit rates, has also
triggered regulatory moves to help banks. London now looks set to build its own
CNH infrastructure, in co-operation with Hong Kong. Competition with Shanghai
is not imminent, but should be welcomed.
 We look for a 1.4% appreciation in the CNY against the USD in 2012. Rising CNH
deposit rates have pushed up USD-CNH forwards as interest rate differentials
play a greater role. We believe longer USD-CNH forwards offer an attractive
place for corporates to hedge USD receivables and CNY payables. Relative value
investors should hold USD-CNY NDF steepeners.
 We estimate that investments in Dim Sum corporate bonds could reach CNH
350-400bn by end-2012, and that new issuance will be around CNY 180bn. New
supply will be easily absorbed. We recommend that investors rotate into the
higher-quality, more liquid single-A and strong BBB names.



The Renminbi Insider



15 February 2012 2
Focus – Loosening, but steady does it
 Gradual loosening is now happening; the falling draft discount rate
is evidence of this
 Growth will be weak in Q1 and early Q2, but we look for a better H2
 Deleveraging in the real-estate and infrastructure sectors will drag
on

Are monetary conditions in China really being loosened? We think so, though it is
happening extremely gradually. In this section, we examine how the People‟s Bank of
China (PBoC) and other parts of the government slowed down the economy in 2010-
11 and can now gradually reverse course to support growth in 2012. Premier Wen‟s
comments last weekend that policy will be “micro-adjusted” in Q1, partly because
orders have deteriorated in up- and downstream industries, are another significant
signpost of this shift. There is still some economic pain to come in H1, but policy will
be supportive in 2012.

1. The PBoC drove up banks‟ cost of funding in 2011 through aggressive
sterilisation operations. The collapse in FX inflows (and thus exogenous money
supply) in Q4-2011 drove funding costs higher.
2. After a year of higher credit costs, and restrictions on real-estate and
infrastructure lending, demand growth slowed significantly from Q3-2011. Some
deleveraging has happened. Inflation has fallen dramatically. The economic
picture is clouded by the Lunar New Year holiday, which causes all manner of
data distortions, but we believe overall demand continues to contract mildly.
3. The PBoC has begun to react. Funding costs have peaked. Base money is now
growing again. The PBoC has scaled back its sterilisation activities. Borrowing
costs are falling, gradually.
4. Regulatory guidance has also eased: banks have been allowed to roll over
infrastructure-related loans and are encouraged to lend to first-time apartment
buyers and builders of ordinary apartments.
5. The easing so far has been gradual. However, it will continue, and we expect
demand growth to pick up in Q2. The infrastructure and real-estate sectors will
still face a tough year, though.
Chart 1: Credit growth slowed dramatically in 2010-11 but has now turned
Cement production and real credit growth, % y/y


Sources: CEIC, Standard Chartered Research
Real credit growth
Cement
-10%
0%
10%
20%
30%
40%
Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12
Stephen Green, +852 3983 8556
Stephen.Green@sc.com

Wei Li, +86 21 6168 5017
Li.Wei@sc.com

Lan Shen, +86 21 6168 5019
Lan.Shen@sc.com




The Renminbi Insider



15 February 2012 3
Cooling the economy meant restricting credit, driving up funding costs
2010 and 2011 were all about higher funding costs and quantitative restrictions on
lending. Chart 1 shows the precipitous deceleration in credit growth, which really
began to bite in 2011. The PBoC enforced an unofficial CNY 7.5trn credit quota, and
unlike in 2010, regulators‟ efforts to curb non-bank credit growth proved effective.
Infrastructure and real-estate lending were especially squeezed via administrative
rules. The economy began deleveraging in 2011.

Partly as a result of quantitative restrictions, banks‟ funding costs also rose
significantly in 2011. Chart 2 shows the winning rate at the commercial banks‟
auction for Ministry of Finance (MoF) deposits. Budgetary funds are mostly held in
the Treasury Single Account (TSA) at the PBoC, though local governments and other
governments hold an enormous amount of cash outside of the TSA in commercial
bank accounts too. The MoF would like to earn some interest on its funds, as the
PBoC reportedly does not pay anything; so for the past few years, it has been
auctioning off some funds to banks for three- to nine-month periods.

These auction rates are therefore a good indicator of banks‟ marginal cost of funds.
Costs for six-month money had risen to nearly 7% by early 2011 from 1-2% in 2008.
This increase of 500-600bps far exceeds the 125bps increase in official deposit rates
during the same period. These rates mirror rates paid on wealth management
deposits, which have ballooned in scale in the last two years (see On the Ground,
14 September 2010, ‘China – How to prevent a housing bubble’). Both of these
new forms of bank liabilities tell us about marginal funding costs for the banks. These
costs are important to track as the credit quota is loosened.

Overall demand in the economy reacted to higher funding costs, and to all the
restrictions put in place in the real-estate and infrastructure sectors. Chart 3 shows
the slowdown in air travel in 2010-11, while Chart 4 shows the deceleration in cement
and steel production.


Chart 2: Banks’ marginal cost of funds rose, is now stable
Auction rates for MoF deposits at commercial banks, % p.a.
Chart 3: Slower, but still in the air
Air travel, passenger trips, % y/y



Sources: CEIC, Standard Chartered Research Sources: CEIC, Standard Chartered Research
9-month
6-month
3-month
0
1
2
3
4
5
6
7
8
Dec-06 Dec-07 Dec-08 Dec-09 Dec-10
Local
Regional
International
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
Banks’ funding costs were pushed
up aggressively in 2010-11, and are
peaking now


The Renminbi Insider



15 February 2012 4
We think China is still slowing, despite Lunar New Year data effect
The Lunar New Year is playing havoc with the January-February statistics, including
the official manufacturing PMI numbers (which we show in Chart 5). The index hit
50.5 in January, the month when most factories in China were closed for the holidays,
suggesting a m/m expansion. The data needs to be seasonally adjusted for the Lunar
New Year, and the official PMI series shows evidence of better seasonal adjustment
since 2008. But we remain sceptical about the adjustment in January. The
Markit/HSBC manufacturing PMI for January was 48.8; the seasonal adjustment
method used for this data is probably better than for the official PMI, and the recent
history of this series suggests an ongoing contraction since July 2011 (with the
exception of an above-50 print in October). We may have to wait for the official PMI
for March for a more reliable gauge of where we are in the cycle, but we think Q1 will
be weak overall. The services-sector PMIs have also weakened, suggesting that the
slowdown is now also affecting urban consumption.

Inflation has fallen, and February data will highlight that trend
Despite the higher-than-expected January number, inflation pressures have fallen
meaningfully, and the authorities are increasingly dovish in their outlook. CPI inflation
came in at 4.5% y/y in January (Chart 6), significantly above the market consensus of
4.0%. Food and services prices surged during the Lunar New Year holiday. Chart 7
shows this holiday-induced ebb and flow in prices for food. In 2011, the holiday fell
on 3 February, just after the turn of the month. Services prices peaked in January
2011, as migrant workers usually leave their jobs early or demand higher pay to stay
as the holiday approaches. Food prices peaked in February 2011 as the food-
focused family celebrations kicked in. (Both of these effects usually hit in the same
month, as they did in January 2012.) As a result, the y/y CPI inflation number for
January 2012 was hit by a surge in food inflation to 10.5% from 9.1% in December,
while the impact on services prices was more muted.

February will see a reversal of these effects, with CPI inflation – especially for food –
falling. Important food prices have already fallen since the New Year. Indeed, looking
at historical m/m food price increases during the Lunar New Year month, January
2012 saw the smallest gains since 2006 (1.5%, compared with an average of 3.9%
between 2006 and 2010). If the historical pattern holds, y/y food inflation should fall
to 8.8% in February from 10.5% in January, and overall CPI inflation should slow to
3.8% y/y. The National Development and Reform Commission (NDRC) published a
Chart 4: Less steel and cement growth
Production, % y/y
Chart 5: PMIs have probably fallen below 50
Official and Markit/HSBC manufacturing PMIs



Sources: CEIC, Standard Chartered Research Sources: CEIC, Standard Chartered Research
Crude steel
Cement
-20%
-10%
0%
10%
20%
30%
40%
50%
Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11
Official
Markit/HSBC
35
40
45
50
55
60
65
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12
The Lunar New Year has played
havoc with the J anuary data; we will
need to see February’s data to get a
sense of how weak the economy
really is
CPI inflation should fall to 3.8% y/y
in February, rekindling hopes of
more loosening


The Renminbi Insider



15 February 2012 5
note on its website in which it argued, like, us, that the January uptick was mostly
driven by increased New Year demand for food, and partly driven by bad weather.
Critically, upstream producer prices are flirting with deflation, rising only 0.7% y/y in
January. We maintain our call that CPI inflation will average 2% in 2012.

The discount rate is falling gradually, suggesting some loosening
As a result of weaker demand and lower inflation, credit conditions are set to
normalise. Rates in the interbank market reflect both FX inflows and PBoC open-
market (sterilisation) operations. Many small banks borrow at these levels. The cost
of short-term trade financing is now also falling, albeit very gradually. Chart 8 shows
the discount rate, at which banks discount bank-issued drafts presented to them by
corporates wanting cash. This is a critical financing rate for SMEs, which often rely
on drafts to pay their bills. It is also the best indicator of marginal financing costs
outside of traditional loans. Things got very tight in Q3-2011 as banks reduced their
issuance of drafts; in Q4, banks often refused to discount them at all. In H2-2011, the
bank regulator moved to stop banks from on-selling their discounted drafts to trust
companies (which were packaging them up in wealth management products), and
asked banks to hold reserves against the deposits they took when they issued a draft
to a client. The discount rate is still historically high, but since the Lunar New Year
holidays, it has fallen from 8.5% to 7.2% (as of 9 February), and continues to fall.

An additional liquidity driver is exogenous money supply, which picked up again in
January. China‟s base money growth in the last few years has resulted from the
PBoC printing Chinese yuan (CNY) to pay for US dollars presented by commercial
banks. The dollars go into the FX reserves, and the newly printed CNY goes into the
economy (after some 80% has been sterilised). The pace of liquidity creation
depends on the speed of this FX inflow-induced printing. Chart 9 shows the m/m
growth in the stock of these FX purchases.

In Q4-2011, the pace of FX purchase growth collapsed – an effect mirrored in the
stagnation of the FX reserves (On the Ground, 16 December 2011, ‘China – The
suddenly weak Renminbi’). Since mid-December, though, we have seen the
recovery of net USD selling by onshore banks and corporates, the return of mild CNY
appreciation expectations, and a return to moderate FX reserve growth. We believe
January saw a recovery in FX purchases, with some CNY 200bn (USD 32bn) of
buying by the PBoC. We expect the PBoC to want to maintain moderate appreciation
Chart 6: A holiday-induced rebound in CPI inflation
CPI inflation, y/y and m/m SAAR 3mma, %
Chart 7: February to see a reversal of New Year effect
Food inflation, m/m SAAR, %



Sources: CEIC, Standard Chartered Research Sources: CEIC, Standard Chartered Research
-10%
-5%
0%
5%
10%
15%
Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12
CPI, y/y %
CPI, m/m SAAR, 3mma, %
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
2009 2010 2011 2012
Month after
CNY month
The draft discount rate should
continue to fall from its peaks,
easing funding costs for SMEs


The Renminbi Insider



15 February 2012 6
expectations – if there is one thing the central bank fears more than FX inflows, it is
FX outflows. As a result of this, as well as our expectations of current and capital
account surpluses in 2012 (albeit smaller than in 2011), we think exogenous money
supply growth should be supportive of liquidity.

Credit growth has picked up on a y/y basis
Credit growth has turned a corner – and this is as reliable an indicator as we are
likely to find of an imminent pick-up in investment activity (for more details, see the
economics piece in this issue of The Renminbi Insider). Chart 1 shows the upturn in
credit growth (adjusted for inflation) and cement production. While it is not an
aggressive pick-up, it should be enough to stabilise the economy‟s slowdown in Q2.
January loan growth was equivalent to 12% y/y in real terms, continuing its uptick.
We expect new loans in February to be CNY 900bn to CNY 1trn in size.

Q1 still feels fragile, but policy loosening will continue at the margin
The February data should allow us to compare January/February 2012 with 2011,
and may provide some clues about the direction of the economy. We believe the
manufacturing sector is still contracting or flat, and that the services sector is slowing.
The residential real-estate and infrastructure sectors are suffering severe cash-flow
stresses, and though loans are being rolled over, rising payables must be causing
pain. Deleveraging in these sectors has some way to go, and will likely drag on.

Recognition of the problems now seems to be filtering through to the State Council
leadership. Last weekend, Premier Wen noted that “companies upstream and
downstream are facing difficulties”. He then said stated, “We need to meet problems
early, move with speed, and… micro-adjust policy in Q1”. This was the first time
Premier Wen has put a timetable on policy „micro-adjustment‟. We interpret this as a
dovish signal.

We expect the Q1 data to be pretty ugly, though official y/y GDP growth will stay above
8%. Premier Wen may well announce a 7.5% growth target at the National People‟s
Congress meeting in March, but we maintain our call of 8.1% for the year. The fall in
CPI inflation and policy loosening at the margin – whether monetary, fiscal or
administrative in nature – should reassure the market and set the stage for moderately
faster growth momentum in H2. But 2012 is shaping up to be a tough year.
Chart 8: SME funding costs are gradually falling
Discount rate, % weighted average
Chart 9: Base money growth slowed, then sped up in
January (FX purchases, m/m %, 3mma)



Sources: CEIC, Standard Chartered Research Sources: CEIC, Standard Chartered Research
0
2
4
6
8
10
12
14
16
18
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12
-1%
0%
1%
2%
3%
4%
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12


The Renminbi Insider



15 February 2012 7
CNH market – Shifting sands, expanding universe
 Stalling deposits are just part of the ever-shifting CNH landscape
 Increasing CNH’s global relevance is key to sustaining momentum
 Competition from Shanghai is neither imminent nor a bad thing

Making sense of a changing CNH market
The CNH market has its fair share of sceptics. The market turbulence that triggered
sharp sell-offs in CNH and Dim Sum bonds in September 2011 unveiled flaws in the
system, especially in the CNY trade settlement conversion arrangement. However,
the biggest flaw was the then-common perception that CNH should always trade at a
stable premium to onshore CNY. The authorities have since taken measures to
strengthen the market. Sentiment, however, has been slow to recover.

Just when the CNH premium finally returned in early January, two pieces of news
rekindled doubts about the market. First, the 6.2% m/m drop in CNH deposits in
Hong Kong in December triggered talk of stagnation. Second, China‟s latest plan to
turn Shanghai into a financial centre with international CNY trading, clearing and
pricing capabilities by 2015 fuelled talk that Hong Kong would eventually be
marginalised. We believe both concerns are way overdone. CNH deposits are just
one part of the CNH market, and Hong Kong will benefit from the expansion of the
CNH market to other centres.

In this section, we deconstruct the recent drop in CNH deposits in Hong Kong and
look at its broader implications. We then look at how the Renminbi is set to make
further inroads in Japan and the West. Finally, we dispel the myth that Shanghai is
on its way to marginalising Hong Kong as the offshore Renminbi centre.

What creates (and drains) CNH deposits?
A wide range of factors affect Renminbi deposit levels in Hong Kong; we show them
in Table 1. Some have a bigger impact than others; some cause month-to-month
changes, while others effect change over time. Since the beginning of Q4-2011, CNH
deposit growth has stagnated.

The structural reasons for this include (but are not limited to):

 Reduced CNY appreciation expectations, which have discouraged investment
demand and retail conversion
 Ongoing cross-border remittances from Dim Sum issuers
 The creation and expansion of other recycling channels, including CNH FDI
 Most importantly, the continued rebalancing of CNY trade settlement flows as
more Chinese exporters convert to CNY invoicing

The reversal of CNH deposits in December was probably also partly associated with
the loss of the CNH premium over CNY. This caused a change in the behaviour of
both exporters and importers.


Kelvin Lau, +852 3983 8565
Kelvin.KH.Lau@sc.com


The focus on stalling deposit
growth misses the still-exciting big
picture of the CNH market
The structural shift in the CNY trade
settlement mix, exacerbated by
short-term factors, has changed the
CNH deposit outlook


The Renminbi Insider



15 February 2012 8
The exporters. The CNH discount created the incentive for mainland exporters to buy
CNH offshore via their offshore subsidiaries before making cross-border transfers back
into the mainland under the CNY trade settlement scheme. (Before, when the CNH was
in premium, they had less incentive to move away from receiving and converting USD
receipts onshore to using the offshore market.) Such corporate-related buying of
„cheaper‟ offshore CNH was evident throughout Q4-2011, after the CNH moved into
discount in late September. However, given that it takes time for trading firms to convert
their invoices, the market impact likely reached a pinnacle in December. In our view,
this boost to CNH-denominated mainland exports also helps to explain the still-strong
overall CNH trade remittances reported by the Hong Kong Monetary Authority (HKMA)
for December (Chart 2). So, corporates are not backing out of CNY trade settlement,
but the mix of the types of corporates using the scheme has changed.



Table 1: What goes in and out of the CNH deposit pool
Key factors affecting CNH deposits in Hong Kong
Key channels
Effect on CNH deposit level
in Hong Kong
Impact Remarks
CNY trade settlement
+ Mainland importer pays
overseas seller
HIGH
Over 80% of China's CNY trade settlement is done with Hong Kong;
in Q4-2011 alone, Hong Kong handled CNY 585bn worth of
Renminbi cross-border trade settlement remittances.

Impact on CNH deposits is primarily a function of the relative size of
the opposing CNY trade settlement flows. Any small change on one
or both sides could result in large swings on a net basis.

The mainland‟s CNY export/import mix dropped from 1:9 in 2010 to
1:5 in Q1-2011, 1:2.9 in Q2, and 1:1.7 in Q3. Hypothetically, based
on Hong Kong's CNY trade settlement size in Q4-2011, a further
drop in the ratio to, say, 1:1, during the quarter would have meant a
loss of CNY 150bn in CNH deposits.
– Mainland exporter receives
overseas payment
Dim Sum bond
issuance
– Remittance of funds raised
back to mainland *
MEDIUM
Dim Sum bond issuance and the CNH FDI scheme complement
each other. Total Dim Sum issuance was around CNY 170bn in
2011 (an average of CNY 43bn per quarter); from its official launch
in October until mid-December, 74 cases of CNH FDI had been
approved, for a total investment amount of CNY 16.5bn.
CNH FDI / ODI
+ CNY leaving mainland via
ODI *
MEDIUM
– CNH entering mainland via
FDI *
Retail conversion and
remittance
+ Retail buying of Renminbi
via clearing bank
LOW to
MEDIUM
Retail CNH deposits, which were the main channel for creating CNH
deposits prior to the introduction of CNY trade settlement scheme,
now account for less than 30% of the total. The shift in Hong Kong
households‟ deposit mix to CNH has clearly been overwhelmed by
CNH deposits, created via the 10% of China's total trade flows that
are denominated in Renminbi.
– Retail selling of Renminbi
via clearing bank
– Retail Renminbi remitted to
mainland *
R-QFII
– CNH collected and
invested back into
mainland *
LOW
An initial overall quota of only CNY 20bn (the same size as the most
recent sovereign Dim Sum issuance), shared among 21 qualified
institutions; unlike via trade settlement, there are limited cross-
border flows once quotas are filled.
Banks invest in
onshore bonds
– Idle CNH deposits
deployed back into
mainland *
LOW
Similar to RQFII, limited to qualified trade settlement banks in Hong
Kong under a quota system.

* The reverse also applies for cross-border repatriation of money originally invested /placed/borrowed Source: Standard Chartered Research


The Renminbi Insider



15 February 2012 9
The importers. Under normal circumstances, a CNH premium would allow mainland
importers to buy more USD via their Hong Kong subsidiaries before paying their
overseas suppliers. Such selling of Renminbi in the offshore market adds to the
offshore CNH deposit pool. However, when a CNH discount emerges, importers
have an incentive to use the trade settlement conversion channel via the clearing
bank, since this allows them to buy USD offshore at the (higher) onshore CNY price
for eligible trades denominated in Renminbi. The quota for this conversion channel
was reinstated and expanded in Q4 and stayed open throughout the quarter, allowing
a lot of CNY selling at the onshore (rather than the lower CNH) price. This shift in
behaviour has a big impact on overall CNH liquidity in Hong Kong, because when
this quota is used, the trade settlement banks square their positions with the clearing
bank, and the clearing bank then squares with the People‟s Bank of China (PBoC). In
this case, the Renminbi, rather than being added to the offshore deposit pool, is
channelled back into the mainland. This is another way in which the quota system
distorts the CNH market (we discussed other distortions in the previous issue of The
Renminbi Insider, 21 November 2011, ‘Rebuilding after the storm’).

The good news is that since early January, the CNH has again been trading „rich‟ to
onshore CNY. An obvious reason for this was that exporters were buying CNH,
driving the CNH back towards the onshore rate. The return of the premium also
means that Renminbi coming from mainland importers stays in Hong Kong; thus, the
premium should help create a floor for CNH deposits for now. Market forces should
also help to create a new equilibrium, mainly by pushing CNH interest rates higher as
a result of new channels for using CNH, and also via rising competition for CNH
deposits among banks. It is also clear to us that the CNH market is entering another
new phase in 2012, just as 2011 was different to 2010.

From too much CNH liquidity to too little
Banks in Hong Kong spent much of H1-2011 fretting over having too few outlets
to manage big CNH deposits. Since then, however, CNY trade flows have
become more balanced, CNH lending has exploded (higher USD interest rates
make borrowing CNH more attractive), and more CNH has been „recycled‟ back
into the mainland (via strong Dim Sum issuance, new quotas for cross-border
investment, etc.).

Chart 1: Change in trade settlement slows deposit
growth…
CNH deposits in Hong Kong (CNY bn)
Chart 2: … despite strong overall momentum
Cross-border CNY trade remittances in Hong Kong (CNY bn)



Sources: Bloomberg, Standard Chartered Research Sources: Bloomberg, Standard Chartered Research
-60
-40
-20
0
20
40
60
80
0
100
200
300
400
500
600
700
Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11
0
50
100
150
200
250
300
Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11
Return of CNH premium and market
adjustments should help stabilise
CNH deposits for now
Monthly changes (RHS)
CNH deposits outstanding


The Renminbi Insider



15 February 2012 10
None of this has killed the CNH market; it has merely changed the dynamics. For one,
CNH deposit rates are set to climb further given still-strong CNH loan demand. This
will also compensate depositors for lower Renminbi appreciation expectations. For
the same reason, the cost of issuing Dim Sum bonds could rise.

Tighter CNH liquidity has also helped to trigger some relaxation of policy for banks in
Hong Kong. On 17 January, the HKMA announced two such changes for banks
operating Renminbi businesses in Hong Kong:

 Renminbi risk management limit: Banks in Hong Kong are required to
maintain reserves of 25% of their respective CNH deposit bases. Two new
items can now be included in the ratio: sovereign Dim Sum bonds issued by
China‟s Ministry of Finance (MoF) and holdings of CNY bonds in the mainland
interbank bond market (through the quota system). Originally, only Renminbi
cash, the settlement account balance with the clearing bank, and the balance
maintained in the Fiduciary Account (through the clearing bank with the PBoC)
were included.

Expanding the list of eligible reserve items gives banks more flexibility in
managing their CNH liquidity. More CNH becomes lendable, and banks can earn
more on their reserves (the clearing bank and the Fiduciary Account only pay
0.629% on balances, compared with more than 1% for a MoF bond). Moreover,
expanding the use of Dim Sum bonds (currently, only those issued by the MoF
are eligible, but quasi-sovereign and financial institution bonds will hopefully be
included in the future) increases incentives for financial institutions to hold them.

A separate and more recent relaxation of HKMA rules on Hong Kong banks‟
statutory liquidity ratio, or SLR (the proportion of banks' Renminbi liquefiable
assets that can be counted towards satisfying the SLR was increased) should
result in a similar boost in demand for CNH assets.

 Renminbi net open position (NOP): Banks in Hong Kong previously needed to
maintain a Renminbi NOP of +/-10%; the HKMA raised this ratio to 20%. The
NOP is defined as the ratio between the difference of on-balance-sheet
Renminbi assets and liabilities against the bank‟s CNH balance sheet (total
Renminbi assets or liabilities, whichever are larger). While banks have been
managing their NOPs through CNH FX swaps for some time, the additional
„headroom‟ for CNH exposure provided by this adjustment should still be
welcomed, especially for banks in Hong Kong with smaller CNH deposit bases.

Looking ahead, we believe that policy makers will focus on both promoting CNH
deposit creation in Hong Kong and further encouraging the development of the CNH
markets. For example, we look for policies aimed at expanding CNH overseas direct
investment (ODI) from China as a means of boosting CNH liquidity.

But with so many moving parts, forecasting CNH deposits is not straightforward.
While the re-emergence of the CNH premium should support inflows, our original
forecast of CNY 900bn in deposits by end-2012 now looks ambitious. Barring further
major policy relaxation, end-2012 deposits of CNY 700-800bn look more realistic.
CNH interest rates are set to climb
further and prompt more policy
responses in 2012
We now see CNH deposits coming
in at CNY 700bn-800bn by end-2012


The Renminbi Insider



15 February 2012 11
The expanding CNH universe
Following a policy-induced „big bang‟ in mid-2010, when the CNH market sprang to
life, the CNH universe has been expanding since. While more balanced trade flows
mean that fewer „surplus‟ CNH deposits are now generated, with some 10% of
China‟s total trade now denominated in CNH, demand for buying, selling, hedging
and investing in Renminbi offshore has only risen. The CNH market thrives on rising
two-way trade settlement and investment flows, while growing interest from offshore
corporates and investors adds to the market‟s depth and breath. Now that the Hong
Kong CNH market is growing nicely, the next question is how to make the Renminbi
relevant to the rest of the world. The current market infrastructure only needs to be
tweaked to facilitate such expansion. It is already capable of bringing CNH to every
corner of the world, through a bank system branching out from Hong Kong or from
onshore agent banks. But more can be done.

Two recent breakthroughs, in particular, are important in bringing offshore markets
closer together in their use of CNH:

 China-Japan co-operation: The PBoC announced on 25 December that China
and Japan would collaborate in promoting the use of their currencies in bilateral
trade and financial transactions. Tokyo said it planned to start investing in
China‟s sovereign debt (some USD 10bn to start), which would make Japan the
first developed economy to hold CNY bonds as reserve assets. The
arrangement envisions creating a direct trading market for the CNY and
Japanese yen (JPY); encouraging Japanese corporates to make direct Renminbi
investments in the mainland; allowing Japanese companies to issue Renminbi
bonds; and promoting trade settlement in both currencies.

 Hong Kong-London co-operation: On 16 January, the HKMA and the UK
Treasury announced that a forum would be set up to promote offshore CNY
market development between the two international financial centres.
Representatives from five private-sector banks (including Standard Chartered)
from both sides will participate. The focus will be on the joint development of
clearing and settlement systems, on improving CNH liquidity overseas, and on
developing more CNH products.

Interestingly, this new arrangement is set to be driven by Hong Kong – and its
private sector – rather than by mainland China. This indicates that Hong Kong
will be critical in extending the CNH‟s market reach by utilising its well-
established CNH financial infrastructure, liquidity and expertise. In turn, London
is well positioned to maximise its time-zone
1
advantage, its proximity to China‟s
biggest export market (Europe), and its deep markets. We see London
developing its own CNH-related financial infrastructure and regulatory framework;
and over time becoming a complementary hub for CNY trade settlement and
building its own CNH market. We believe this would be a win-win result for both
London and Hong Kong.


1
The importance of expanding time-zone coverage is reflected in the HKMA‟s recent decision to extend its Renminbi real-time gross settlement (RTGS) service by
five hours (covering the period from 8:30-23:30, rather than 8:30-18:30) starting at end-June 2012. The idea is to cover European and US working hours in order to
reduce cross-border settlement risk and attract European and US banks to use Hong Kong‟s Renminbi settlement services.

The long-term outlook remains
promising as the CNH becomes
more relevant and accessible
globally


The Renminbi Insider



15 February 2012 12
Shanghai: Friend or foe?
In late January, China‟s National Development and Reform Commission (NDRC) and
the Shanghai municipal government released a blueprint for developing Shanghai
into an international financial centre. The original goal of achieving this by 2020 is still
intact; this blueprint is an action plan for 2012-15. It includes the opening up of local
markets to more foreign investors, measures to increase market size and the number
of financial professionals, and the expansion of Shanghai‟s capital-raising capabilities.
The most eye-catching part of the plan is the commitment to making Shanghai a
global Renminbi trading, pricing and clearing centre by 2015.

Some see this as a threat to Hong Kong‟s leading role in the CNH market. But for this
part of its plan to work, Shanghai needs to replicate what Hong Kong offers (by
carving out an offshore market onshore in Shanghai), or China needs to liberalise its
capital account enough to substantially accelerate onshore-offshore market
convergence. Otherwise, Shanghai‟s new CNH clearing capability will be no different
from the current „agent bank‟ arrangement. More trade settlement flows may end up
going through Shanghai, but substantial ring-fencing means that a wider range of
CNH products and services would still have to be provided offshore. In terms of
becoming a pricing hub, as long as there is not full cross-border Renminbi fungibility,
the onshore and offshore markets will continue to be driven by different dynamics.

We believe that the idea of carving out an „offshore market‟ in Shanghai lacks
sufficient high-level support within China‟s government, at least for now. We have
also long argued that China‟s capital account liberalisation is likely to be a very
gradual process. In our view, the current approach of internationalising the Renminbi
via a liberal current account, plus selective and controlled capital account relaxation,
is proving effective and is still the way forward.

By the time Shanghai becomes truly competitive, whether on CNH alone or with a
fully convertible Renminbi, the currency‟s global penetration will be so great that the
pie will be more than big enough for two international financial centres to share. Hong
Kong‟s competitiveness will continue to be derived from its sound rule of law, its high
concentration of international financial institutions and professionals, and its well-
established regional and international financial linkages. Moreover, we believe that
the more space Shanghai gets to develop CNY markets, the more space Hong Kong
will also get.



Shanghai’s aspirations need not,
and will not, come at the expense of
Hong Kong


The Renminbi Insider



15 February 2012 13
FX – USD-CNH repricing on higher CNH returns
 Rise in CNH returns triggers upswing in USD-CNH forwards
 Longer USD-CNH forwards now offer attractive context for corporate
hedging of USD receivables, CNY payables
 Relative value investors should hold USD-CNY NDF steepeners

CNY forward analytics
CNH returns rise amid broader loan restraint
While the launch of an official „fix‟ for CNH funding rates may be some way off, in
early January Hong Kong‟s Treasury Market Association (TMA) began publishing
interbank offered rates in CNH from three contributing banks, including Standard
Chartered Bank. These published rates are testimony to the substantial improvement
in CNH returns over the past nine months. Offered rates rise from 2.6% at 3M to
3.1% at 1Y, well above the „base‟ net interest rate paid by the CNH clearing bank (at
a mere 0.629%). The rise in the cost of CNH funding reflects both prospects for a
broader range of uses for CNH and, more immediately, the impact of global market
volatility on Hong Kong financial markets.

China‟s Vice Premier Li Keqiang signalled during his visit to Hong Kong last August
that Hong Kong would play a key role as a bridge between mainland China and the
global financial system. This would give CNY sourced in Hong Kong a range of uses,
from financing FDI into the mainland to investment in equities through the „R-QFII‟
route. To the extent that Hong Kong funding acts a substitute for onshore funding,
this favours the convergence of CNH funding rates with those onshore.

Just as important in the short term, however, has been the impact of global financial-
market turbulence. HKD deposits contracted on a y/y basis in September 2011 in a
dynamic similar to that in late 2008 (see Chart 1), likely reflecting rising risk aversion.
In contrast, HKD loan growth had been healthy for much of the year (rising 16.6% y/y
in Q2), which created the potential for a „crunch‟ for banks caught between shrinking
deposits and buoyant credit growth (Chart 1). Banks‟ efforts to contain loan growth in
other currencies sparked a rapid expansion of their CNH loan books. As CNH slipped
into a discount to the onshore CNY, this also stalled the upswing in CNH deposits in
Hong Kong, and thus the supply of CNH liquidity from the mainland.
Chart 1: HKD loan and deposit growth (% y/y)
2008-style HKD deposit decline y/y helped boost funding rates
Chart 2: 2Y forwards on three curves – USD-CNY NDF,
USD-CNH and USD-HKD



Sources: Bloomberg, Standard Chartered Research Sources: Standard Chartered Research, Bloomberg
HK deposits
HKD loans
-20
-10
0
10
20
30
40
50
Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11
7.71
7.73
7.75
7.77
7.79
6.15
6.25
6.35
6.45
6.55
Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12
USD-HKD 2Y (RHS)
USD-CNH 2Y
USD-CNY NDF 2Y (RHS)
Robert Minikin, +852 3983 8567
Robert.Minikin@sc.com

Eddie Cheung, +852 3983 8566
Eddie.Cheung@sc.com

Newly published CNH interbank
offered rates are well above the
clearing bank’s net interest rate
Prospective mainland capital
account liberalisation has helped to
lift returns
Weaker deposit growth in HKD and
CNH has also played a role


The Renminbi Insider



15 February 2012 14
The launch of the TMA CNH published offered rates was a signal of a maturing
interbank market in which banks are now comfortable indicating public lending rates.
This has reinforced the power of interest rate differentials as a driver of the USD-
CNH forward curve. Banks can now buy USD-CNH in the deliverable forwards,
hedge the resulting transaction with a spot sale of USD-CNH, and then carry the
CNH received as a deposit asset until the maturity date of the forward trade. Amid
broader balance-sheet stresses, the USD-CNH swap market also became a potential
source of local funding to complement funding in other currencies. As a result, the
repricing of the longer-dated forwards (such as the 2Y) in USD-CNH has closely
tracked that in other local markets such as the HKD 2Y forward (see Chart 2).

CNH forward, spot and option market pricing issues
The USD-CNH forward curve is caught between two attractors: the forward interest
rate parity (FIRP) curve and expectations of future CNY (and CNH) appreciation. So
is the upward adjustment in the USD-CNH forward curve to FIRP complete? CNH
interbank offered and funding rates are still not the same, so the precise FIRP curve
will differ between institutions. Based on average TMA rates, the gap with USD
HIBOR stretches out from 1% overnight to 1.9% at the 1Y deposit. The implied
forward points (at 305 pips and 1,215 pips, respectively) are well above actual USD-
CNH forward pips (at 134 pips and 427 pips), suggesting that the convergence with
FIRP is arguably incomplete. Nevertheless, USD-CNH is now being priced much
closer to the FIRP than consensus forecasts for the USD-CNY trajectory (Chart 3).

The new power of interest rate differentials to price the USD-CNH forward curve has
implications for both relative value investors and corporate hedgers. Wide gaps
between consensus projections for CNY gains and the USD-CNH forward curve will
likely become the new norm, as they are in fully deliverable currencies. Local liquidity
and return dynamics in CNH and USD are set to play a key role in driving USD-CNH
forward pricing, rather than swings in CNY appreciation expectations alone. For
multinational corporations with forward CNY payables/USD receivables, the upswing
in USD-CNH forwards is simply reinforcing the attractiveness of hedging in this
market rather than in the non-deliverable forwards (NDFs). In the wake of the USD-
CNH forward curve repricing, the 2Y forward (at 6.406) is a full 7.6% above our USD-
CNY forecast trajectory at that point (around 5.95).


Chart 3: The ’FIRP’ USD-CNH forward curve, market
forwards and the consensus trajectory for USD-CNY
Chart 4: USD-CNY, USD-CNY onshore and USD-CNY NDF
forward curves to 1Y forward



Sources: Bloomberg, Standard Chartered Research Sources: Standard Chartered Research, Bloomberg
6.10
6.15
6.20
6.25
6.30
6.35
6.40
6.45
0.00 0.25 0.50 0.75 1.00
Years forward
Forward interest rate parity (FIRP)
USD-CNH forward
Consensus USD-CNY
forecast trajectory
6.250
6.275
6.300
6.325
6.350
0.00 0.25 0.50 0.75 1.00
Years forward
USD-CNH
USD-CNY NDF
USD-CNY onshore
More functional CNH interbank
market has boosted role of interest
rate parity in USD-CNH forwards
USD-CNH forwards are still priced
below forward interest rate parity,
but well above consensus forecasts
for USD-CNY
Upswing in USD-CNH forwards
substantially boosts attractiveness
of context for corporate hedging of
USD receivables


The Renminbi Insider



15 February 2012 15
Alongside the impact on forward pricing, the broadening of the potential range of uses
for CNH and the rise in CNH interbank returns have played a key role in increasing the
CNH premium against CNY. CNH has traded consistently at a premium to CNY since 6
January 2012, and the median premium since then – at 0.22% – is actually higher than
the median over the lifetime of the market as a whole (the median from October 2010 to
date is 0.16%). The positive premium reflects both CNY appreciation expectations and
the CNH‟s carry characteristics, so it is reasonable that a broader improvement in the
return on CNH deposits has revived the CNH premium. However, the powerful risk
appetite revival of early 2012 is vulnerable to reversal, and we project that CNH will
trade at par with CNY onshore until mid-2012 (amid weaker risk appetite), before a
sustained CNH premium (of around 150 pips, or 0.24%) re-emerges in H2. The deeper,
more stable spot market for USD-CNH in recent months is particularly reassuring for
potential corporate users of the deliverable markets for hedging purposes, and has also
improved USD-CNH option-market liquidity.

CNY outlook and corporate strategy
We are making a modest adjustment to our USD-CNY forecast profile, trimming our
USD-CNY projection for end-Q1-2012 to 6.33 from 6.36 given the more general
scaling back of our expectations of USD strength in Asia (for more details, see FX
Alert – Asian currencies, 7 February 2012, ‘Two-way Asian FX volatility in H1,
appreciation in H2’). Our (unchanged) mid-year forecast of 6.31 is not far from
current spot, and trend appreciation in the CNY against the US dollar re-emerges in
our forecasts only in H2, when we expect an improving global growth outlook and
broader USD weakness. We put the CNY‟s net appreciation for 2012 at only 1.4%,
although the faster pace of CNY gains in H2-2012 should extend into 2013. Indeed,
the case for medium-term CNY appreciation remains intact given China‟s persistent
trade and current surpluses, alongside healthy total factor productivity gains.

Against this backdrop, multinational corporates with USD receivables and CNY
payables beyond six months forward should hedge these on the USD-CNH forward
curve (or, less attractively, in the USD-CNY NDFs). USD-CNH option volatilities are
also typically above those in the USD-CNY NDFs, and USD-CNH calls trade at a
premium to puts (see Chart 7). Against this backdrop, these corporates should also
consider strategies that sell USD upside through longer-expiry USD-CNH calls. The
2Y 35-delta USD-CNH call returns a premium of 1.78% (at 5.25 implied volatility) and
has a strike of 6.58, 10.6% above our 2Y USD-CNY projection.
Chart 5: CNH premium to onshore CNY Chart 6: USD-CNH and USD-CNY onshore forwards, USD-
CNY NDFs alongside our forecasts for USD-CNY



Sources: Bloomberg, Standard Chartered Research Sources: Standard Chartered Research, Bloomberg
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12
5.90
6.00
6.10
6.20
6.30
6.40
6.50
0.00 0.25 0.50 0.75 1.00 1.25 1.50 1.75 2.00
Years forward
USD-CNH
USD-CNY NDF
USD-CNY onshore
USD-CNY Forecasts
Improved CNH returns have revived
the CNH premium to CNY, while
CNH option-market liquidity has
improved markedly
A stronger CNY under current
circumstances both meets an
internal need and enhances external
market stability
A stronger CNY under current
circumstances both meets an
internal need and enhances external
market stability


The Renminbi Insider



15 February 2012 16
Relative value in USD-CNY forwards
The rise in CNH returns and the resulting upswing in USD-CNH forwards have a
broader relevance. Over time, multinational corporates will likely switch from hedging
in the USD-CNY NDFs to the USD-CNH forwards, while relative value investors will
look to exploit CNH forward cheapness by selling USD-CNH and buying USD-CNY in
the NDFs. Over time, these forces should prompt at least partial convergence of the
twin offshore forward curves, following the sharp divergence seen in early 2012
(Chart 8 shows the gap between selected USD-CNH forward points and those in the
USD-CNY NDF). Given that H1-2012 will likely see little net CNY appreciation and
that USD-AXJ may head higher (before retreating in H2), we expect any
convergence in the coming months to be through a stronger USD in the NDFs than
through a weaker USD in the CNH forwards. Given this, the Standard Chartered FX
Trading Portfolio is long USD in the USD-CNY 6M NDFs, while periodically hedging
out any near-term CNY appreciation risks around major events such as Chinese Vice
President Xi Jinping‟s visit to Washington this week.

The forward cheapness of CNH compared to our forecast trajectory for CNY also
suggests value in USD-CNH put spreads as a „buy and hold‟ strategy given the
recent substantial improvement in USD-CNH option-market liquidity. The following
option strategy buys the ATMF USD-CNH put and sells the 22-delta put, where the
strike lies very close to our USD-CNH forecast trajectory one year out.

Trade idea: Buy 1Y USD-CNH put spread
 Spot reference: 6.2950
 Buy 1Y ATMF (6.3415) USD-CNH put at 4.15% vol
 Premium paid: 1.62% of notional
 Sell 1Y 22-delta (6.1850) USD-CNH put at 3.25% vol
 Premium received: 0.40%
 Net cost of 1.22%, strikes are 2.53% apart






Chart 7: ATMF implied option volatilities and 25-delta risk
reversals in USD-CNH and USD-CNY options (%)
Chart 8: Gap between 3M, 6M and 12M forwards in USD-
CNH and USD-CNY NDFs (pips)



Sources: Bloomberg, Standard Chartered Research Sources: Standard Chartered Research, Bloomberg
0
1
2
3
4
5
0.00 0.50 1.00 1.50 2.00
Expiry in years
USD-CNH ATMF
USD-CNH 25D RR
USD-CNY ATMF
USD-CNY 25D RR
-100
100
300
500
700
900
1,100
Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12
1Y
6M
3M
USD-CNH and USD-CNY NDF
convergence in the coming months
will likely come through a stronger
USD in the NDFs
USD-CNH 1Y put spreads offer
value for relative value investors


The Renminbi Insider



15 February 2012 17
Credit – Dim Sum bonds – A maturing market
 Demand for Dim sum bonds remains strong; both Chinese and
international issuers continue to tap the markets
 CNH deposit growth slows as currency appreciation expectations
moderate
 A shift in demand-supply dynamics will improve credit differentiation
in the Dim Sum bond space

Dim Sum hunger should remain strong
The Dim Sum bond market suffered a period of volatility in Q3 and Q4-2011
alongside other risk assets. Overall risk appetite has made a strong comeback this
year, but the CNH bond market – especially the high-yield (HY) segment – continues
to lag. Market liquidity at times of stress has become a primary concern. Investors
realise that CNH appreciation is not a one-way bet, and this has weakened one of
Dim Sum‟s main attractions. The shift in the CNH forward curve to upward-sloping
from downward-sloping in mid-2011 (shown in Chart 9 at the end of this section) is
indicative of this change. The onshore CNY forward curve, in contrast, continues to
indicate marginal appreciation, as Chart 10 shows. The CNH bond space is
undergoing a paradigm shift as it evolves into a more mature market with a better
balance between demand and supply.

We believe the outlook for Dim Sum bond issuance in 2012 is positive for a variety
of reasons. First, there is still a mismatch between demand for and supply of
assets in the CNH market. Total CNH deposits in Hong Kong were CNH 588bn at
the end of 2011, against CNH 220bn of outstanding bonds (representing 37% of
the deposit base). In our view, as the focus on CNY currency appreciation is
reduced, we expect a higher proportion of deposits to be deployed in higher-
yielding corporate Dim Sum bonds, (around 50-55%, in our view). While deposit
growth has slowed sharply, we estimate end-2012 deposits at CNH 700-800bn.
Assuming that 50-55% of this amount is used for investments in corporate bonds,
the Dim Sum bond base could reach CNH 350-400bn by end-2012. Thus, new
supply will easily be absorbed, in our view.


Chart 1: CD issuance spiked in 2011
Dim Sum bond issuance since 2007 by collateral (CNY bn)
Chart 2: CNH premium has been volatile
CNH, CNY currency rates and premium



Sources: Bloomberg, Standard Chartered Research Sources: Bloomberg, Standard Chartered Research
CD
Others
0
50
100
150
200
250
2007 2008 2009 2010 2011 2012 YTD
CNY minus
CNH (RHS)
CNY
CNH
-0.15
-0.10
-0.05
0.00
0.05
0.10
0.15
0.20
6.0
6.1
6.2
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
Sandeep Tharian, +44 20 7885 5171
Sandeep.Tharian@sc.com


CNH bond markets have lagged
USD bond markets in the rally since
early 2012 as the CNY appreciation
story moderates


The Renminbi Insider



15 February 2012 18
Second, CNH issuers, to the extent that they are permitted to remit funds back to the
mainland, will continue to be attracted by the lower rates prevailing in the CNH
market relative to the higher CNY onshore rates available on a variety of debt
instruments. Thus, as long as onshore liquidity in China continues to be tight,
Chinese corporates will have a strong need to issue in the Dim Sum bond markets.
Heavy CD issuance by a number of banks in 2011 testifies to the importance of this
cost advantage (Chart 1).

Third, we expect some traditional issuers in the USD bond space (both Asian and
others) to tap the liquidity provided by the Dim Sum bond space. This is in line with
the trend seen in other local-currency bond markets, such as THB, MYR and SGD.

Dim Sum supply likely close to 2011 record highs
We expect healthy Dim Sum bond supply of around CNY 170-180bn in 2012. This
would be only slightly lower than record supply of CNY 190bn in 2011. Year-to-date,
supply has already hit CNY 22bn. While offshore issuance yields have been slowly
creeping up, they are still attractive enough for higher-quality issuers to tap the
offshore market rather than raise funds onshore. The demand side should remain
strong, as many international investors appear keen to ride the CNY appreciation
story via Dim Sum bonds rather than outright instruments. With the counterparty risk
of such instruments perceived as more or less the same as the credit risk (especially
by higher-quality credits and financial institutions), investors may prefer Dim Sum
bonds for improved yield, along with currency appreciation. As an example, the total
return from holding the BCHINA CNH 1Y bond (implied yield plus currency
appreciation) would be considerably higher than investing in a currency instrument
with BCHINA as the counterparty.

In our view, there are three broad classes of investors in Dim Sum bonds:
1. Outright investors in CNH credits, who consider the CNH to be a pure „local
currency‟ against which they are benchmarked, with little consideration for the
CNH as a currency play. This group includes banks with CNH liquidity,
corporates holding CNH liquidity from their business proceeds, or real money
funds with retail/institutional CNH money.
2. International investors who are interested in CNH appreciation prospects and
can invest in Dim Sum bonds on an outright/unhedged basis. This investor class
includes currency-focused hedge funds and private banking clients.
Chart 3: CNH FX rate is affected by market volatility
CNH FX rate vs. VIX Index
Chart 4: Dim Sum bonds sell off more
Dim Sum bond yield vs. JACI yield (%)



Sources: Bloomberg, Standard Chartered Research *Bank of China indices used for Dim Sum bonds;
Sources: Bloomberg, Standard Chartered Research
CNH
VIX (RHS)
0
10
20
30
40
50
60
6.0
6.2
6.4
6.6
6.8
Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11
Dim Sum
index
JACI
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12
We expect healthy Dim Sum bond
supply of around CNY 170-180bn in
2012
We expect increased
disintermediation in the CNH space
as investors look for higher carry
returns on their CNH savings


The Renminbi Insider



15 February 2012 19
3. Investors who look at relative value in USD and CNH paper and choose to hold
Dim Sum bonds purely on an asset-swapped basis, because they offer relative
value versus comparable USD paper. Such investors include global real money
funds and hedge funds that are credit-focused rather than currency-focused.

In 2012, we could see an increase in international investors wanting to play the
appreciation trend through CNH bonds. However, this will be contingent on an
improvement in overall macro sentiment and an easing of concerns about a hard
landing in China. We do not expect a hard landing – we forecast 8.1% GDP growth in
2012, followed by 8.7% in 2013, and expect stronger macro data in H2-2012 to allay
such fears. We also expect the CNY to continue its appreciation trend in H2-2012
after being relatively flat in H1, acting as another supportive factor.

Credit differentiation developed in late 2011
The evolution of the yield differential between onshore and offshore bonds shows a
clear trend of credit differentiation among various classes of CNH bonds:

1. Sovereign/supranational/policy bank issuers that have issued bonds in the CNH
market
2. HG issuers (including multinationals) rated in the single-A to BBB category
(excluding the highly rated China sovereign but including quasi-sovereign issuers)
3. Sub-investment-grade issuers rated in the BB to single-B range.

These credit classes were trading at relatively tight yields to each other in 2010 and early
2011 as investors bet „en masse‟ on the CNH bond market. Towards the latter half of
2011, investors started to differentiate between CNH bonds based on their credit quality.
Sovereign CNH bonds, while volatile, continue to be well supported by CNH bond yields
that are lower than onshore CNY yields (shown in Chart 5). The extent of the
convergence between onshore (CNY) and offshore (CNH) corporate yields increases as
one goes down the rating spectrum, with the trend being most pronounced in the HY
sector. Offshore HY corporate bond yields started to underperform their onshore
counterparts as early as end-June 2011, and are currently higher than onshore yields
(Chart 8). This may have reflected idiosyncratic issues plaguing the Chinese HY
corporate space. Given that international investors (who are involved in the USD and
CNH space rather than onshore) reacted more strongly to such news, offshore HY
corporate bonds tended to underperform comparable onshore bonds.
Chart 5: Sovereign bonds trade tight in offshore market
Sovereign offshore vs. onshore bond yields (%)
Chart 6: Multinationals issue in CNH for access to the
currency rather than attractive yields
Multinational CNH vs. USD bond yields (%)



Sources: Bloomberg, Standard Chartered Research Sources: Bloomberg, Standard Chartered Research
CGB 15
onshore
CGB 15
offshore
0
1
2
3
4
Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12
MCD 13 USD
MCD 13 CNH
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12
A better balance between demand
and supply in the Dim Sum bond
space is likely to lead to better
credit differentiation


The Renminbi Insider



15 February 2012 20
Dim Sum bond yields to converge slowly with onshore bond yields
The credit differentiation seen in H2-2011 could continue well into 2012 as global risk
appetite goes through multiple risk-on/risk-off cycles. Liquidity may be the key driver
of CNH yields in 2012. As the CNH market matures and the demand/supply balance
normalises, arbitrage opportunities between onshore (CNY) and offshore (CNH)
bonds will tend to disappear, resulting in the convergence of offshore and onshore
bond yields. This yield convergence could be slower for higher-quality CNH bonds
such as the sovereign or single-A/strong BBB corporates, as they enjoy marginal
investor demand. HY corporate CNH bond yields, which are currently wider than
those of comparable onshore bonds, could remain at elevated levels and susceptible
to further widening of 130-150bps, especially if macro conditions worsen.

We recommend that CNH investors rotate into higher-quality, more liquid, lower-
duration, single-A and strong BBB corporate names and remain Neutral to marginally
Underweight the HY corporate sector. Given the lower duration of CNH instruments,
total return losses from yield/spread widening should be fairly limited, especially if the
mild currency appreciation trend continues.


Chart 7: HG corporate bonds have been stable
HG corporates offshore vs. onshore bond yields (%)
Chart 8: Offshore HY rates remain elevated
HY corporates offshore vs. onshore bond yields (%)



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


CNPCCH 14
onshore
CNPCCH 14
offshore
2
3
4
5
6
7
Sep-11 Oct-11 Nov-11 Nov-11 Dec-11 Jan-12 Jan-12
SHASHU 14
offshore
SHASHU 14
onshore
5
6
7
8
9
10
11
Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12
Chart 9: CNH forward curve is upward-sloping
Comparison of CNH forward rates on selected dates
Chart 10: CNY forward curve still indicates appreciation
Comparison of CNY forward rates on selected dates



Sources: Bloomberg, Standard Chartered Research Sources: Bloomberg, Standard Chartered Research
5-Jul-11
9-Feb-12
6.2
6.3
6.4
6.5
1M 2M 3M 6M 9M 12M
5-Jul-11
9-Feb-12
6.1
6.2
6.3
6.4
6.5
1M 2M 3M 6M 9M 12M


The Renminbi Insider



15 February 2012 21
Economics – Angels, demons and investment
proxies
 After a heroic search, we have yet to find a decent leading indicator
of investment activity
 Wheel-loader sales growth lags investment, while cement production
is coincidental
 Credit growth is what we are left with

Given that investment makes up half of China‟s economy, it would be nice to have
a leading indicator or two to tell us where investment is going over the next three
months. Unfortunately, after following one tantalising clue after another, we are
still left with credit growth as the only leading indicator of investment. And it is far
from perfect.

Wheel-loaders to the rescue?
Wheel-loader and excavator sales growth initially seemed like a promising idea. Such
machines are used to dig holes and move earth and gravel, and are therefore
essential for building roads, real-estate projects and mines. Surely companies would
buy lots of them when they saw a wave of new investment on the horizon? Alas, no –
as Chart 1 shows, wheel-loader and excavator sales lag real investment growth (as
measured by quarterly real fixed asset investment numbers, which themselves have
some issues). There are a number of possible explanations for this. Companies
probably increase use of their existing equipment to meet a pick-up in activity; only
when they are maxed out do they invest in new machines. Financing may also play a
role – it is common for local manufacturers to finance these purchases, so the
availability of financing (which is affected by overall monetary conditions) probably
affects sales too. Also, many households have reportedly invested in such machinery
as a store of wealth. They believe a few years of renting it out will cover the cost and
pay a better return than a bank account deposit (and the entry barrier is lowered if
they are getting financing).

Chart 1: Wheel-loaders lag, rather than lead, official investment growth
Real fixed asset investment growth and wheel-loader and excavator sales, % y/y


Sources: CEIC, Standard Chartered Research
Wheel-loader and
excavator sales
(LHS)
Real FAI
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
Stephen Green, +852 3983 8556
Stephen.Green@sc.com

Ben Hartwright, +852 3983 8507
Ben.Hartwright@sc.com

Juntung Wu, +852 3983 8505
JunTung.Wu@sc.com



The Renminbi Insider



15 February 2012 22
Cement production is better
We then looked at cement production growth, which we have highlighted before (On
the Ground, 17 January 2011, ‘China – What is the economy really doing, and
where is it going?’). As Chart 2 shows, cement production growth is at least
coincidental with real investment growth. Incremental production growth can come
quickly from idled plants being restarted. We like cement more than steel production
as an investment proxy – it is difficult to store and transport, so it should respond
quickly to changes in underlying demand. Steel inventories, in contrast, can be built
up and drawn down (and are difficult to track).

Both cement and steel production growth are looking weak. Cement production grew
7% y/y in Q4-2011, and crude steel production grew 3%, as Chart 3 shows. We
expect the downturn to have continued in Q1-2012.


Chart 2: Cement production tracks investment growth
Real fixed asset investment growth and cement production, % y/y



Sources: CEIC, Standard Chartered Research

Chart 3: Cement and steel indicate that investment growth continues to weaken
Crude steel and cement production, % y/y, 3mma



Sources: CEIC, Standard Chartered Research
Cement, 3mma
Real FAI
-20%
-10%
0%
10%
20%
30%
40%
50%
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
Crude steel
Cement
-20%
-10%
0%
10%
20%
30%
40%
50%
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012



The Renminbi Insider



15 February 2012 23
Then there are projects under construction
What about projects under construction as a leading indicator of demand? Again, this
sounds like a good idea: once a project is approved and started, there should be a
lead-in phase before spending really ramps up. A new wave of recently appointed
officials are arriving in local governments and will want to start projects to prove their
growth-enhancing abilities. Indeed, growth in the number of projects perked up in Q4.
However, as Chart 4 shows, growth in projects more or less tracks real investment
growth. Thus, there is very limited leading information here.

And finally, credit growth
And so we come (again) to credit. Investment projects around the country are
extremely credit-constrained right now. The Ministry of Railways is only slowing
paying its suppliers; real-estate developers are delaying payments for materials and
delaying land lease payments to local governments; road companies around the
country are struggling with rising payables too. Local government investment
Chart 4: Project growth more or less tracks investment
Projects under construction and real fixed asset investment, % y/y



Sources: CEIC, Standard Chartered Research

Chart 5: Real credit growth has picked up
Cement production and real credit growth, % y/y



Sources: CEIC, Standard Chartered Research
Projects under
construction, 3mma
Real FAI
0.0
0.1
0.2
0.3
0.4
0.5
-20%
-10%
0%
10%
20%
30%
40%
50%
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
Real credit growth
Cement
-10%
0%
10%
20%
30%
40%
Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12



The Renminbi Insider



15 February 2012 24
vehicles (LGIVs) are having their loans rolled over, limiting the amount of new funds
that banks can lend out. At a State Council meeting last week, Premier Wen made a
point of saying that it was important for key projects to get financing. We surmise that
the financing squeeze has to be serious and national in scale for Premier Wen to talk
about it.

In Chart 5, we show that credit growth is probably the best leading indicator out there
for investment activity. It shows cement production growth (which we take as a proxy
for investment growth, and for which we have longer-run data) against loan growth
(adjusted for inflation). We note that credit growth has recently picked up a little from
its trough, a signal that very mild credit easing is happening, even without aggressive
cuts in the required reserve ratio. If historical patterns hold, we should see a
moderate pick-up in cement production and investment growth in Q2-2012.






The Renminbi Insider



15 February 2012 25
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.




The Renminbi Insider



15 February 2012 26

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: 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‟s 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 clarifying the eligibility criteria for firms tapping the trade
conversion quota, and increased documentation requirements.

December 2011: CSRC granted first batch of licences under R-QFII scheme. These were later approved
and granted a quota by SAFE. China and Japan agreed to collaborate in promoting the use of their
currencies in bilateral trade and financial transactions.















2011




2012










2011
January 2012: Hong Kong‟s three note-issuing banks began to publish Renminbi interbank offered rates.
HK Securities and Futures Commission approved 17 R-QFII products with a total investment quota of
CNY 17bn. The HKMA and UK Treasury announced the launch of a joint private-sector panel to enhance
co-operation between Hong Kong and London on the development of the offshore Renminbi business.
HKMA also announced adjustments to RMB risk management and net open position limits, easing CNH
funding.

February 2012: Rules on Hong Kong banks‟ statutory liquidity ratio were relaxed to increase the
proportion of banks' Renminbi liquefiable assets that can be counted towards the ratio.





The Renminbi Insider



15 February 2012 27
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 1.05
MoF CGB Sovereign 20-Dec-2010 3,000 1.60 20-Dec-2012 <1 1.07
MoF CGB Sovereign 06-Sep-2011 5,000 1.60 06-Sep-2013 1 1.21
MoF CGB Sovereign 01-Dec-2010 2,000 1.00 01-Dec-2013 1 1.20
MoF CGB Sovereign 18-Aug-2011 6,000 0.60 18-Aug-2014 2 1.25
MoF CGB Sovereign 27-Oct-2009 500 3.30 27-Oct-2014 2 1.24
MoF CGB Sovereign 01-Dec-2010 2,000 1.80 01-Dec-2015 3 1.75
MoF CGB Sovereign 18-Aug-2011 5,000 1.40 18-Aug-2016 4 1.95
MoF CGB Sovereign 18-Aug-2011 3,000 1.94 18-Aug-2018 6 2.25
MoF CGB Sovereign 01-Dec-2010 1,000 2.48 01-Dec-2020 8 2.55
MoF CGB Sovereign 18-Aug-2011 1,000 2.36 18-Aug-2021 9 2.55


Supranationals
Issuer Sector Issue date
Size
(CNY mn)
Coupon Maturity Tenor
Indicative
bid yield (%)
Asian Development Bank
Supranational
bank
21-Aug-2010 1,200 2.85 21-Aug-2020 8 2.80

CNH bank bonds
Issuer Sector Issue date
Size
(CNY mn)
Coupon Maturity Tenor
Indicative
bid yield (%)
Agricultural Development Bank China Policy bank 17-Jan-2012 2,100 3.00 17-Jan-2014 2 2.60
Agricultural Development Bank China Policy bank 17-Jan-2012 550 3.20 17-Jan-2015 3 2.86
Agricultural Development Bank China Policy bank 17-Jan-2012 350 3.50 17-Jan-2017 5 3.25
Bank of China Policy bank 30-Sep-2010 2,200 2.65 30-Sep-2012 <1 2.81
Bank of Communications HK FI bank 04-Mar-2011 1,000 1.00 04-Mar-2013 1 3.28
China Construction Bank HK FI bank 03-Jun-2011 1,000 1.05 03-Jun-2013 1 3.30
Exim Bank of China Policy bank 02-Dec-2010 4,000 2.65 02-Dec-2013 1 2.45
ICBC (Asia) FI bank 13-May-2011 400 1.10 13-May-2013 1 3.12
ICBC (Asia) FI bank 24-Sep-2010 1,000 2.25 24-Sep-2012 <1 2.83
China Development Bank Policy bank 16-Jan-2012 867 3.10 16-Jan-2015 3 2.96
China Development Bank Policy bank 16-Jan-2012 133 3.45 16-Jan-2017 5 3.35
China Development Bank Policy bank 19-Jan-2012 1,500 4.20 19-Jan-2027 15 4.15

CNH multinational bonds
Issuer Sector Issue date
Size
(CNY mn)
Coupon Maturity Tenor
Indicative
bid yield (%)
America Movil Telecom 08-Feb-2012 1,000 3.50 08-Feb-2015 4 3.32
Caterpillar Financial Services Industrial 12-Jul-2011 2,300 1.35 12-Jul-2013 2 2.62



The Renminbi Insider



15 February 2012 28

CNH corporate bonds
Issuer Sector Issue date
Size
(CNY mn)
Coupon Maturity Tenor
Indicative
bid yield (%)
Beijing Enterprise Water Corporate 30-Jun-2011 1,000 3.75 30-Jun-2014 3 4.08
CNPC Corporate 19-Oct-2011 2,500 2.55 26-Oct-2013 1 2.46
China Power New Energy Corporate 29-Apr-2011 500 3.75 29-Apr-2014 3 7.23
Lafarge Shui On Cement Corporate 09-Nov-2011 1,500 9.00 14-Nov-2014 2 7.06
Eastern Air Overseas HK Corporate 08-Aug-2011 2,500 4.00 08-Aug-2014 3 4.32
Right Century Corporate 03-Jun-2011 3,000 1.85 03-Jun-2014 3 4.15
China Merchants Holdings (Hong Kong) Corporate 19-Nov-2010 700 2.90 19-Nov-2013 2 3.93
Lotte Shopping Corporate 09-Feb-2012 750 4.00 09-Feb-2015 3 4.00
Pacific Andres Res Dev Corporate 02-Jun-2011 600 6.50 02-Jun-2014 3 14.96
Road King Infrastructure Ltd. Corporate 25-Feb-2011 1,300 6.00 25-Feb-2014 2 15.82
Tsinlilen Group Corporate 10-Nov-2011 1,300 5.75 10-Nov-2014 2 6.15
Hai Chao Trading Co. Ltd. Corporate 04-Aug-2011 900 2.00 04-Aug-2014 3 4.59
Zhongsheng Group Corporate 21-Apr-2011 1,250 4.75 21-Apr-2014 3 9.67
*All data as of 8 February 2012; Sources: Bloomberg, Standard Chartered Research



The Renminbi Insider



15 February 2012 29
Product update – Latest CNH products available in Hong Kong
CNH product Available? Remarks
Spot Yes Daily CNH interbank liquidity of USD 1.1bn, 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 is now at USD 200-300mn, with trading in the 1-5Y;
longer tenors are less liquid.
Money market Yes
Interbank trading is growing. Tenors up to 1Y are traded, with most trading concentrated in the
1-6M. Banks‟ overseas entities are also gradually entering the market. Daily interbank CNH
lending has been around CNH 2-3bn in recent weeks
CDs Yes CDs launched
IRS Yes
The CNH 3M SHIBOR IRS is still quite illiquid, with daily turnover of up to CNH 100mn. The
CNY NDIRS (USD) has daily liquidity of around CNY 1bn.
Structured products Yes
Structured investments (linked to LIBOR) are available. USD-CNH FX hedges such as
structured forwards for corporates are also available.
Bonds Yes Growing numbers of both regular and synthetic issues; daily turnover is CNH 100-200mn.
Source: Standard Chartered Research



The Renminbi Insider



15 February 2012 30
Key China views and projections
Central bank outlook

Current To end-2012 Next Forecast next change Last change

Benchmark rate (%) (bps) meeting Date Our forecast 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 6.30 ↑ ↔ Mild CNY appreciation vs. USD to extend into medium term
Buy USD-CNY 6M NDF
Sell USD-CNY 3W NDF

10Y bond 3-6M 6M+ Fundamentals Current trades
China 3.49 ↑ ↑ Growth and inflation to slow down before rebounding in H2-2012 -

Forecasts – Economic

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

2011 2012 2013 2014 2011 2012 2013 2014 2011 2012 2013 2014

China 9.2 8.1 8.7 7.0 5.4 2.0 3.6 4.0 3.5 1.9 2.7 3.1

Forecasts – FX
End-period Period average
2012 2013 2012 2013 2014 2015 2016
Q1 Q2 Q3 Q4 Q1 Q2
USD-CNY 6.33 6.31 6.26 6.21 6.18 6.15 6.28 6.10 5.85 5.65 5.45
forward 6.31 6.31 6.32 6.32 6.33 6.33
USD-CNH 6.33 6.31 6.245 6.195 6.165 6.135

Forecasts – China rates
End-period Period average
2012 2012 2013 2014 2015 2016
Q1 Q2 Q3 Q4
Policy rate



1Y lending rate 6.56 6.56 6.56 6.56 6.56 7.31 (YE)
Bonds

2Y 3.00 3.00 3.10 3.30 3.10 3.40 3.60 3.60 3.60
10Y 3.50 3.50 3.70 3.90 3.65 3.85 4.00 4.00 4.00
Swaps

7-day repo 3.50 2.50 2.70 2.90 2.70 3.50 4.50 4.50 4.50
2Y 3.23 3.23 3.33 3.53 3.33 3.63 3.83 3.83 3.83
10Y 3.66 3.66 3.86 4.06 3.81 4.01 4.16 4.16 4.16

CNH market
2011
Apr May Jun Jul Aug Sep Oct Nov Dec
Remittances for Renminbi cross-border trade settlement (CNY bn)
Hong Kong 134.2 153.4 205.1 149.0 185.8 190.6 161.5 185.0 239.0
Apr-Jun 2011 Jul-Sep 2011 Oct-Dec 2011
China 597.3 583.4 N/A
Sources: HKMA, PBoC, Standard Chartered Research


The Renminbi Insider



15 February 2012 31
Key China views and projections (continued)
Chart 1: CNH deposit growth (CNY bn)
End-December CNH deposits: CNY 588.5bn
Chart 2: Our estimates of daily market turnover (USD mn)
End-January daily turnover in CNH spot: USD 1.1bn



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 2012
Forecast
0
200
400
600
800
1,000
Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Dec-12
Demand and savings deposits
0
500
1,000
1,500
2,000
2,500
3,000
Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12
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
1,528
1,668
1,819
2,003
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 dipped in early
2012 but remains above June 2010 post-de-peg level



Sources: Bloomberg, Standard Chartered Research Sources: BIS, Standard Chartered Research
0
50
100
150
200
250
2007 2008 2009 2010 2011 2012 YTD
CNY NEER -
Our Daily
Estimate
BIS CNY
NEER -
Monthly
94
96
98
100
102
104
106
Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12


The Renminbi Insider



15 February 2012 32
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 13 February 2012)
Coverage total (IB%)
Positive 13 (15.4%)
Stable 168 (20.8%)
Negative 65 (15.4%)
Total (IB%) 246 (19.1%)


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:
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: -





The Renminbi Insider



15 February 2012 33
Analyst Certification Disclosure: The research analyst or analysts responsible for the content of this research report certify that: (1) the views expressed and
attributed to the research analyst or analysts in the research report accurately reflect their personal opinion(s) about the subject securities and issuers and/or other
subject matter as appropriate; and, (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views
contained in this research report. On a general basis, the efficacy of recommendations is a factor in the performance appraisals of analysts.

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Document approved by
Robert Minikin
Senior FX Strategist
Data available as of
06:30 GMT 15 February 2012

Document is released at
06:30 GMT 15 February 2012







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