The Shanghai Free Trade Zone: Interest Rate Strategy
CNH: Onshore deregulation, offshore expansion
September 30, 2013
Interest rate strategy
CNH: Onshore deregulation, offshore expansion
DBS Group Research
30 September 2013
The Shanghai Free Trade Zone (SFTZ) opened on 29 Sep. According to the blueprint, financial innovations including RMB convertibility and interest rate liberalization are the priorities on the reform agenda (see “Shanghai Free Trade
Zone & the reinvigoration of China”, 26 Sep 2013). These reforms will make the RMB an increasingly important currency in the global FX market. However, some worry that the establishment of SFTZ will undermine the development of offshore RMB markets. Such fear is unwarranted. Looking at the Eurodollar market could help shed light on how offshore market grows in spite of onshore deregulation. Experience from the Eurodollar market
During the 1960s, changes in US regulations such as reserve requirements, interest rate restrictions, and borrowing limits made offshore banking more attractive to local banks. Consequently, USD liquidity migrated to London, where non-US banks were not subject to regulation by the Federal Reserve. The Eurodollar market grew rapidly as a result.
The Eurodollar grew rapidly even after US capital controls and key taxes were lifted In the late-1980s and early-90s, most of the aforementioned regulations were eliminated. For instance, the Federal Reserve lowered reserve requirements on large-denomination domestic deposits to zero; in effect removing that ‘tax’ on local intermediation. But the Eurodollar share of global dollar banking had grown from 10% in 70s to 20% in 90s and over 30% in mid-2000s. Non-US residents continued to hold the majority of their dollar offshore, and so did the official holders of dollar reserve (mostly overseas central banks). During the 2000s, more than 70% of official dollar reserves was placed outside the US
(Chart 1). And interestingly, LIBOR is the benchmark for today’s US
September 30, 2013
Interest rate strategy
CNH: Onshore deregulation, offshore expansion
DBS Group Research
30 September 2013
The Shanghai Free Trade Zone (SFTZ) opened on 29 Sep. According to the blueprint, financial innovations including RMB convertibility and interest rate liberalization are the priorities on the reform agenda (see “Shanghai Free Trade
Zone & the reinvigoration of China”, 26 Sep 2013). These reforms will make the RMB an increasingly important currency in the global FX market. However, some worry that the establishment of SFTZ will undermine the development of offshore RMB markets. Such fear is unwarranted. Looking at the Eurodollar market could help shed light on how offshore market grows in spite of onshore deregulation. Experience from the Eurodollar market
During the 1960s, changes in US regulations such as reserve requirements, interest rate restrictions, and borrowing limits made offshore banking more attractive to local banks. Consequently, USD liquidity migrated to London, where non-US banks were not subject to regulation by the Federal Reserve. The Eurodollar market grew rapidly as a result.
The Eurodollar grew rapidly even after US capital controls and key taxes were lifted In the late-1980s and early-90s, most of the aforementioned regulations were eliminated. For instance, the Federal Reserve lowered reserve requirements on large-denomination domestic deposits to zero; in effect removing that ‘tax’ on local intermediation. But the Eurodollar share of global dollar banking had grown from 10% in 70s to 20% in 90s and over 30% in mid-2000s. Non-US residents continued to hold the majority of their dollar offshore, and so did the official holders of dollar reserve (mostly overseas central banks). During the 2000s, more than 70% of official dollar reserves was placed outside the US
(Chart 1). And interestingly, LIBOR is the benchmark for today’s US
References: Dong He and Robert McCauley (2010): “Offshore markets for the domestic currency: monetary and financial stability issues” BIS Working Papers No. 320. Dong He and Robert McCauley (2012): “Eurodollar banking and currency internationalization” BIS Quarterly Review, June 2012. September 30, 2013 Recent Research