Is The Renminbi A Safe Haven?

Rasmus Fatum
University of Alberta – Department of Marketing, Business Economics & Law
Yohei Yamamoto
Hitotsubashi University
Guozhong Zhu
University of Alberta – Department of Marketing, Business Economics & Law

June 24, 2016

Tokyo Center for Economic Research (TCER) Paper No. E-109
Abstract:

We investigate the relationship between market uncertainty and the relative value of the Renminbi against currencies that the safe haven literature typically considers as the traditional safe haven currency candidates. Our sample spans the February 2011 to April 2016 period. Band spectral regression models enable us to capture that the relationship between market uncertainty and the relative value of the Renminbi is frequency dependent. While we find evidence of some degree of safe haven currency behavior of the Renminbi during the early part of our sample, our findings do not support the suggestion that the Renminbi is currently a safe haven currency or that the Renminbi is progressing towards safe haven currency status.

Is The Renminbi A Safe Haven? – Introduction

Financial market observers and participants have in light of the growing global importance and internationalization of the Renminbi for several years been musing about whether the Renminbi is becoming or has become a safe haven currency (e.g. Chong 2013, Harjani 2014, and Burland 2016).1 While some market participants argue that the Renminbi is already a safe haven, others dismiss this notion and assert that the Renminbi is not sufficiently liquid, not easily convertible, and will not become a safe haven currency until Chinese economic and broader institutional reforms are implemented.2 By contrast, the academic literature is hitherto silent on whether the Renminbi is a safe haven currency. Perhaps this is not surprising in case of the domestically traded Renminbi (CNY) as it does not meet obviously necessary criteria of easy convertibility and high liquidity to be considered a possible safe haven currency, rendering the question of safe haven currency status less meaningful. However, the offshore traded Renminbi (CNH) has since July 2010 been convertible as well as increasingly liquid.3,4 Simply put, nothing stops a market participant, regardless of location or type, from entering and exiting Renminbi denominated cash asset positions in the offshore market. For example, globally traded ETFs tied to Renminbi denominated corporate bonds issued outside of Mainland China (“dim sum bonds”) are readily available, as are globally traded ETFs that mirror the performance of Chinese money market rates. Moreover, a market participant, whether individual, company, or financial institution, can open Renminbi bank accounts in an offshore Renminbi clearing center such as Hong Kong and transfer funds into and out of these accounts without any restrictions (although cross-border fund transfers to and from Mainland China are subject to regulations in Mainland China). As of April 2015 the daily turnover of Renminbi foreign exchange transactions in Hong Kong alone reached the equivalent of USD93 billion, thereby implying that the offshore Renminbi market is highly liquid (Hong Kong Monetary Authority 2016). Since there is no technical hindrance for market participants to consider and employ the Renminbi as a possible safe haven currency, a timely and highly topical research question is whether the Renminbi is becoming or has become a safe haven currency. This is the research question of our paper.

There is no consensus in the safe haven literature as to what constitutes a safe haven currency or, for that matter, which currencies exhibit safe haven currency behavior and when. For example, using daily data Ranaldo and Söderlind (2010) find that during episodes of elevated market uncertainty prior to the global financial crisis the JPY, the CHF, the EUR, and the GBP were exhibiting safe haven currency behavior while Hossfeld and MacDonald (2015) find in their monthly frequency analysis of data spanning more than 26 years that the USD and even more so the CHF qualify as safe haven currencies. Coudert, Guillaumin and Raymond (2014) offer a daily data analysis of the evolution of 26 currencies from both advanced and emerging economies over the 1999 to 2013 period. They find that only the JPY and the USD exhibit safe haven currency properties. The results of Fatum and Yamamoto (2016), also a daily data study, suggest that during the global financial crisis the JPY exhibited the most pronounced safe haven behavior and, furthermore, that safe haven currency behavior is time-dependent, i.e. a given currency may qualify as a safe haven currency over a given period in time but not necessarily over another period in time. In the comprehensive and currently definitive study of what drives safe haven currency behavior, Habib and Stracca (2012) carry out a monthly frequency analysis of the behavior of 52 currencies over the span of almost a quarter of a century and show that only few country-specific factors such as the net foreign asset position and the size of the stock market, and for advanced countries the interest rate spread vis-à-vis the US, are somewhat systematic drivers of safe haven currency behavior.

To answer our research question we consider the relationship between market uncertainty and the relative value of the Renminbi against the USD, the JPY, the EUR, the GBP, and the CHF, i.e. against currencies that the aforementioned safe haven studies consider as possible traditional safe haven currency candidates, over the 28 February 2011 to 30 April 2016 sample period.5 We define a safe haven currency as a currency that increases its relative value against other currencies as market uncertainty increases and follow Habib and Stracca (2012) and many others in using the VIX, the measure of implied volatility of S & P 500 options, as our main indicator of market uncertainty.

In the focal part of our analysis we employ the band spectral regression (BSR) procedure originally developed by Hannan (1963) and Engle (1974, 1978).7 By doing so we are able to take into account the possibility that the relationship between market uncertainty and the relative value of the Renminbi is frequency dependent. Specifically, we model the observed value of the Renminbi as a possible manifestation of both highfrequency movements driven by the reaction of market participants to contemporaneous changes in the perception of market uncertainty as well as low-frequency movements attributable to institutional aspects and long-term objectives of the Chinese monetary authorities.

Our findings for the full sample period suggest that an increase in market uncertainty is on average associated with a decrease in the value of the Renminbi relative to the USD and the JPY and an increase in the value of the Renminbi relative to the GBP and the EUR. Put differently, our full sample results suggest that the Renminbi is “less safe” than the USD and the JPY but “safer” than the GBP and the EUR. This provides evidence consistent with some degree of safe haven currency behavior of the Renminbi. However, when considering more recent sub-samples separately, using the 30 November 2015 SDR basket inclusion announcement and other key institutional events as sample demarcation points, we find that the relative value of the Renminbi vis-à-vis all traditional safe haven currency candidates decreases as market uncertainty increases. The results of our BSR models reveal that during the recent period the relative weakening of the Renminbi as uncertainty increases is due to the high-frequency variation of the Renminbi while the low-frequency variation is generally associated with Renminbi appreciation as uncertainty increases. These findings underline the relevance of distinguishing between high versus low frequency variation in our particular context and lend credence to the suggestion that as market participants consider the Renminbi to be less safe off-setting currency management actions are undertaken as market uncertainty rises. Overall our findings do not support the suggestion that the Renminbi is currently a safe haven currency and in that sense question the notion that the Renminbi is progressing towards safe haven currency status.

Renminbi

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