With RMB loans tightening, foreign currency loans are surging. As the foreign currency credit is not included in RMB lending scale control, they have become a new financing channel.
In addition, with RMB appreciation expectations persisting and USD lending at low rates, arbitrage between the spot market and forward market is emerging and increasing.
In the first 9 months of 2009, single month new foreign currency loans from China's financial institutions contracted by $8.5 billion and $4.2 billion in January and February, respectively, and then grew by $4.3 billion, $7 billion, $12.4 billion, $37.2 billion, $11 billion, $19.2 billion, $17.7 billion in the next seven months through September.
In March, the foreign currency loan balance of financial institutions totaled $235.2 billion, down 11.69%, year-on-year. In September, it was $343.3 billion, up 28.34%, year-on-year.
A senior official from a large state-owned bank told 21st Century Business Herald that foreign currency loans increased significantly over the last three quarters. He said that at his bank they had reached $40 billion (about 270 billion yuan) over the first nine months this year, equivalent to 1/3 of new RMB loans.
One reason for foreign trade firms accustomed to RMB loans to turn to foreign exchange loans is that after the release of 7.37 trillion yuan of new RMB lending in the first half year, the credit market has tightened since the third quarter.
At present, besides the deposit to lending ratio limit, foreign exchange lending is restricted by foreign exchange position rather than RMB credit growth position. As of September, the total foreign exchange loan balance of financial institutions reached $343.3 billion, while the total foreign currency deposit balance amounted to $203.2 billion, with lending to deposit ratio of 169%.
Another important reason for the surge in foreign currency lending is RMB appreciation expectations, and substantial arbitrage space. With the improvement in China's macro situation, pressures for RMB devaluation early in the year have altered to expectations of a rising exchange rate since May and the NDF market is resuming its rally.
On October 26, the one-year forward price of RMB against USD was 6.7554, while the NDF quote was at about 6.63, and the three-year price in NDF market was up to 6.08, anticipating a 10% RMB appreciation in the next three years.Â
At present, a company's US dollar borrowing rate is based on LIBOR plus basis points, and can vary greatly based on different customer ratings and loan terms, ranging from 70 bp to 200 bp. But taking six-month LIBOR for example, the six-month USD lending rate is about 0.67%-0.8%, far below the 4.86% RMB lending rate. Given RMB appreciation expectations, enterprises not only can rely on the exchange rate to cover the cost of foreign currency loans, but also pull in some handsome arbitrage earnings.
If a firm borrows US dollars on the domestic spot market and buys the equivalent US dollar forward on the overseas NDF market, it can not only completely cover its loan needs but also gain 2% of annual revenue after deducting domestic interest rates. Many import and export businesses conduct arbitrage through Hong Kong subsidiaries with NDF trading qualification.Â
Banks' current foreign currency positions are very tight, because of the strong demand for foreign exchange and reduced foreign exchange supply. Banks are unwilling to hold US dollars due to high settlement (selling foreign currency to the central bank). In order to attract US dollar deposits, China's major banks adjust US dollar deposit rates against the global backdrop of no rising US dollar interest rate.Â
As a result, because of the integrated foreign exchange position management of commercial banks, they have to sell US dollar above upper limit to central bank, resulting in the rapid growth of funds outstanding for foreign exchange in the central bank.Â
The RMB balance sheet of financial institutions shows funds outstanding for foreign exchange in September increased by 406.769 billion yuan, the highest in the previous nine months. The figure over the first eight months basically maintained at 100-200 billion yuan. Of that, funds outstanding for foreign exchange in July and in May were 220.456 billion yuan and 242.565 billion yuan, respectively, while they were under 200 billion yuan in other months.
Behind the increasing funds outstanding for foreign exchange is the increasing base money supply that will further challenge money supply control, already beyond the control target.