Page L. Introduction II. Development of the Offshore Renminbi Market II. Assessing Renminbi Internationalization by Analyzing Arbitrage A. Defining progress in Renminbi Internationalization B. Estimating Integration of Onshore and Offshore Renminbi Market C. Arbitrage Between Onshore and Offshore Markets and the Role of Capital Controls.7 D Sources of Divergence of Onshore and Offshore Renminbi Exchange Rates IV. Role of Capital Account Liberalization in Renminbi Internationalization 799 A. Evolution of China's Capital Account Liberalization Strate B. The Impact of Liberalization Measures on Mainland Capital Flows C. Hong Kong SAR's Role in Mainland Capital Account Opening D. Renminbi Internationalization and the offshore renminbi liquidity pool 1245 V Conclusions References Igures 1. Renminbi Cross-Border Trade Settlement 2."Dim-Sum"Bonds Outstanding 3. Renminbi loans in Hong Kong SAR 4. Renminbi liquidity pool in Hong SAR 5. CNY and CNd Spot Exchange Rate Differentials 6. Correlation of Basis and Renminbi Deposits and CDs in Hong Kong SAr 8 7. Correlation of Basis and Renminbi Risk Reversal 8. Mainland China's Private Capital Flows 9. Mainland China's Foreign Direct Investments by Destination 13 10. Mainland Chinas Overseas Direct Investment by Destination 11. Average Asset Allocation to Hong Kong Sar by Equity-Oriented QDII Funds 12. Mainland China's External Positions vis-a-vis Hong Kong sar bank 13. Mainland China's Renminbi FDI and oDl, monthly Flows 14. Mainland China's Renminbi fDi and oDI Percent of Total 144 15. Cross-Border Renminbi Trade Settlement 14 Tables 1. TAR Model estimation results 2. Key mainland China Capital Account Liberalization Measures 3. Measures to Support RMB Market Development in Hong Kong SAR.. 017 Technical Annex2 Contents Page I. Introduction ............................................................................................................................3 II. Development of the Offshore Renminbi Market .......................................................................3 III. Assessing Renminbi Internationalization by Analyzing Arbitrage .....................................5 A. Defining Progress in Renminbi Internationalization ......................................................5 B. Estimating Integration of Onshore and Offshore Renminbi Markets .............................6 C. Arbitrage Between Onshore and Offshore Markets and the Role of Capital Controls ...7 D. Sources of Divergence of Onshore and Offshore Renminbi Exchange Rates ................7 IV. Role of Capital Account Liberalization in Renminbi Internationalization ..........................9 A. Evolution of China’s Capital Account Liberalization Strategy ......................................9 B. The Impact of Liberalization Measures on Mainland Capital Flows ............................11 C. Hong Kong SAR's Role in Mainland Capital Account Opening ..................................12 D. Renminbi Internationalization and the Offshore Renminbi Liquidity Pool ..................14 V. Conclusions .........................................................................................................................15 References ............................................................................................................................... 23 Figures 1. Renminbi Cross-Border Trade Settlement .......................................................................... 3 2. "Dim-Sum" Bonds Outstanding .......................................................................................... 4 3. Renminbi Loans in Hong Kong SAR ................................................................................. 4 4. Renminbi Liquidity Pool in Hong SAR .............................................................................. 5 5. CNY and CNH Spot Exchange Rate Differentials ............................................................. 6 6. Correlation of Basis and Renminbi Deposits and CDs in Hong Kong SAR ...................... 8 7. Correlation of Basis and Renminbi Risk Reversal ............................................................. 8 8. Mainland China's Private Capital Flows ........................................................................... 12 9. Mainland China's Foreign Direct Investments by Destination ......................................... 13 10. Mainland China's Overseas Direct Investment by Destination ........................................ 13 11. Average Asset Allocation to Hong Kong SAR by Equity-Oriented QDII Funds ............ 13 12. Mainland China's External Positions vis-à-vis Hong Kong SAR Banks .......................... 13 13. Mainland China's Renminbi FDI and ODI, Monthly Flows ............................................. 14 14. Mainland China's Renminbi FDI and ODI Percent of Total ............................................ 14 15. Cross-Border Renminbi Trade Settlement ........................................................................ 14 Tables 1. TAR Model Estimation Results .......................................................................................... 6 2. Key Mainland China Capital Account Liberalization Measures ...................................... 10 3. Measures to Support RMB Market Development in Hong Kong SAR ............................ 11 Technical Annex ..................................................................................................................... 17