Bank of America Merrill Lynch has found that RMB appreciation has become a less significant catalyst to growing CNH deposits.

It in its recent GEMS’s Daily Asia report, the banks said the growth level of CNH deposits tends to rise when 1) return of RMB deposits goes up due to a larger RMB/HKD interest rate differential; 2) there are higher expectations of RMB appreciation; 3) economic activity in Hong Kong picks up; and 4) use of RMB for cross-border trade settlement accelerates.

“Interestingly, even though expectations of RMB appreciation have remained an important factor over the last year or so, it has become a less significant driving force than in the pre-crisis period,” said Marcella Chow, Emerging Asia economist at the bank.

Hong Kong’s outstanding RMB deposit base (also called CNH deposits) has often been used as a key indicator of overall CNH liquidity. This is an important benchmark as transactions in the CNH market would likely abate without sufficient liquidity, thereby hindering the development of the offshore RMB centre in Hong Kong, according to the report.

Ever since the launch of the RMB trade settlement in July 2009, RMB deposits in HK have grown tenfold. After reaching a high of RMB 627 billion in November 2011, the CNH deposits declined slowly in early to mid-2012. Growth resumed toward late 2012, and CNH deposits recently rebounded to a record high of RMB 652 billion in February, the report said.

Pre and post crisis

According to BofAML’s sample research, prior to the global financial crisis, real GDP growth, accompanied by the expectations of RMB appreciation (NDF and RMB spread), accounted for most of the growth. Interest rate differential was mostly a drag on the growth during 2004-2007. During the crisis CNH deposits fell, mainly due to the slowing economy as well as lowered expectations of RMB appreciation.

After the crisis, CNH deposit growth picked up again, with cross-border trade settlement (first introduced in July 2009) emerging as a major driving force. Expectations of RMB appreciation remained an important factor, but much less so than in the pre-crisis period. “Over the last year, as change in all these factors has been relatively mild, the growth in CNH deposits has slowed accordingly,” said the bank.

BofAML belives demand for CNH deposits will likely remain robust as Hong Kong’s growth momentum gradually firms up and the global economy slowly recovers. Retail deposits, trade settlement, corporate issuance and hedging flows are thought to continue to support liquidity.

“Even though other offshore RMB centres such as Taiwan and Singapore are gradually emerging, Hong Kong’s competitive position as an offshore RMB centre is strengthened by its geographic proximity, economic linkages and depth of financial market. We expect CNH to appreciate gradually to 6.05 by year-end,” Chow said.