The Onshore–Offshore Exchange Rate Differential, Interest Rate Spreads, and Internationalization: Evidence from the Hong Kong Offshore Renminbi Market

ABSTRACT

This article investigates the linkages among the onshore–offshore exchange rate differential, interest rate spreads, and Hong Kong’s RMB deposits (a proxy for RMB internationalization), based on a structural vector autoregression model. We find that this differential and the spreads have significant effects on Hong Kong’s RMB deposits, but the rise in the spreads will lead to a decline in offshore RMB deposits in Hong Kong. The differential is a stronger factor than spread shocks in explaining fluctuations in Hong Kong’s RMB deposits. Moreover, an analysis of sources of the divergence in the differential and spreads finds several economic variables that are the significant and main factors.

KEY WORDS:

• interest rate spreads
• onshore–offshore exchange rate differential
• RMB internationalization
• state space model
• SVAR

JEL Classification:

• E43
• E44
• F30
• F31
• G15

Acknowledgments

We would like to show our sincere gratitude to the editor, Professor Ali M. Kutan, and the anonymous reviewers for their suggestions and corrections which significantly improved the quality of this article.

Notes

1. The One Belt and One Road is short for “Silk Road Economic Belt” and “21st Century Maritime Silk Road.” It will fully rely on the existing dual multilateral mechanism between China and other countries concerned and with the help of an established and effective platform for regional cooperation. The One Belt and One Road aims to borrow the historical symbols of the ancient Silk Road and hold high the banner of peaceful development, actively develop economic cooperation partnership with countries along the line, building an community of political mutual trust, economic integration, culturally inclusive.

2. https://www.bis.org/publ/rpfx16.htm.

3. On November 30, 2011, global financial markets had a moment of extreme nervousness. Then, the 3-month dollar-euro cross-currency basis swap reached −159 basis points in March 2012, its highest level since 2008, triggering a fall in the currencies of emerging market countries, including the RMB.

4. The “go global” strategy advocates overseas investment.

5. On August 11, 2015, the People’s Bank of China announced the implementation of exchange rate reform including adjustment in the central parity quotation system of the exchange rate of RMB against the US dollar. The adjustment in the spread between the central parity rate and the market exchange rate caused an uproar in the foreign exchange market, the offshore RMB exchange rate overshot the market, and the devaluation of currencies in emerging economies intensified.

6. In the 1960s, Robert A. Mundell and J. Marcus Fleming proposed the Mundell–Fleming model under an open economy (M–F model). The model expands the analysis of the different policy effects under the economic conditions of opening to the outside world and shows whether capital flows freely and different exchange rate regimes affect macroeconomic performance in a country.

Additional information

Funding

This work is supported by the National Social Science Fund of China: [Grant Number 15BTJ009] and Guangzhou International Finance Research Institute Project: [Grant Number 16GFR01A02].