August 12, 2015 / 8:13 AM / 2 years ago

CNH TRACKER-Offshore yuan pool under pressure amid sharp depreciation

HONG KONG, Aug 12 (Reuters) - A long stretch of yuan appreciation helped Hong Kong build a sizable pool of the Chinese currency, and banks got a windfall selling yuan-related products.

Now, two days of tumbles have triggered worries that Beijing may allow a major depreciation, which could discourage global investors from using the currency and make the pool shrink.

The offshore yuan has fared worse than the onshore one after the People's Bank of China's surprise Tuesday move to devalue the currency by nearly 2 percent. Offshore yuan have shed more than 5 percent, compared with about 4 percent onshore.

The big offshore slide will dampen investors' interest to hold yuan deposits, given it has already eaten up all returns they can get from a standard yuan deposit contract, which usually offers 3.0-3.5 percent for a one-year tenor.

In addition, those who invested in structured yuan deposits that bet on yuan appreciation - as seen in past years - are unlikely to get the extra returns these products offered.

Banks in Hong Kong have launched a slew of structured yuan deposit products with attractive returns to compete for new funds after Beijing scrapped a 20,000 yuan ($3,110) daily conversion limit for local residents in last November.

POPULARITY TO FADE?

These products usually offer a guaranteed interest of just 0.3-0.5 percent, but the return can be as high as more than 8 percent if the yuan appreciates to a certain level within the contract periods.

"Yuan structured products have been very popular in Hong Kong thanks to investors' confidence in the yuan, but demand for these products will decline following the sharp depreciation this week," said Frances Cheung, head of Asian ex-Japan rates strategy at Societe Generale.

The yuan's fall comes just as the Hong Kong offshore pool was starting to grow again following a decline at the beginning of this year as some money went northbound through the stock "connector" with Shanghai.

Yuan deposits in the world's biggest offshore yuan hub climbed to 993 billion yuan ($154.51 billion) in June, still below the December peak of 1,004 billion yuan.

Headwinds for overseas yuan deposit growth also come from the widening discount of the offshore yuan against its onshore counterpart, which drains liquidity from the offshore yuan pool.

A BIGGER DISCOUNT

When the offshore yuan is at a discount to the onshore counterpart, Chinese exporters prefer to make use of the offshore market to do conversions as they can get more yuan and then take the funds back to the mainland.

The offshore yuan spot recorded a discount of 1,200 pips on Wednesday, the highest level in almost four years.

"Hong Kong's yuan deposits had been on a long-term uptrend based on a view that RMB would continue its appreciation or at a minimum not devalue vs the HKD. We think yuan deposits will now decline as this long-term view is refuted," said JP Morgan analysts in a note.

Hong Kong is not the only offshore yuan centre feeling the chill from yuan weakness. South Korea, where yuan deposits grew rapidly last year, saw the figure plunge as a large amount of deposits came to maturity amid expectations of falling returns.

Yuan deposits fell by a net $4.18 billion during July to $14.32 billion, the biggest monthly decline since records began in July 2012, data from the South Korean central bank showed.

Some banks have already revised down their forecasts for yuan performance this year, with Societe Generale expecting it to fall to 6.5 in the third quarter and to 6.6 by the end of the year.

$1 = 6.4345 Chinese yuan Editing by Richard Borsuk

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