o 2013 International Monetary Fund WP/3/268 IMF Working Paper Asia and Pacific Department Development of the renminbi market in Hong Kong Sar Assessing Onshore-Offshore Market Integratio Prepared by r. sean Craig, Changchun Hua, Philip ng, and Raymond Yuen Authorized for distribution by Steven Barnett December 2013 This Working Paper should not be reported as representing the views of the mme. The views expressed in this Working Paper are those of the author(s)and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s)and are published to elicit comments and to further debate Abstract Offshore use of the renminbi expanded rapidly in Hong Kong SAR as China sought to develop an international role for its currency while maintaining capital controls. This prompts two questions addressed in this paper: How far advanced is renminbi nternationalization? And, what role does Chinese capital account liberalization play? The first is addressed by testing the extent of integration of offshore and onshore markets for the renminbi using a Threshold Autoregression(TAr)model and finds that there are substantial unexploited arbitrage opportunities. A VAR model is used to indentify factors contributing to this limited market integration and finds that capital controls and shifts in global market sentiment explain much of the divergence in onshore and offshore renminbi exchange rates. To address the second question, the paper shows how capital account measures have been used to promote offshore use of the renminbi more actively in the wake of the global financial crisis, but that this was done asymmetrically with controls on inflows eased to a greater extent than on outflows. It concludes that a more balanced liberalization process will sustain progress in renminbi internationalization JEL Classification Numbers: E61 F33 F36.011019 Keywords:capital controls, offshore financial markets Authors'e-mailAddress:rcraig@imforgchangchunhua(@nomura.com phtng(@hkma. gov hk; rsyyuen @hkma. gov.hk© 2013 International Monetary Fund WP/13/268 IMF Working Paper Asia and Pacific Department Development of the Renminbi market in Hong Kong SAR: Assessing Onshore-Offshore Market Integration Prepared by R. Sean Craig, Changchun Hua, Philip Ng, and Raymond Yuen Authorized for distribution by Steven Barnett December 2013 Abstract Offshore use of the renminbi expanded rapidly in Hong Kong SAR as China sought to develop an international role for its currency while maintaining capital controls. This prompts two questions addressed in this paper: How far advanced is renminbi internationalization? And, what role does Chinese capital account liberalization play? The first is addressed by testing the extent of integration of offshore and onshore markets for the renminbi using a Threshold Autoregression (TAR) model and finds that there are substantial unexploited arbitrage opportunities. A VAR model is used to indentify factors contributing to this limited market integration and finds that capital controls and shifts in global market sentiment explain much of the divergence in onshore and offshore renminbi exchange rates. To address the second question, the paper shows how capital account measures have been used to promote offshore use of the renminbi more actively in the wake of the global financial crisis, but that this was done asymmetrically with controls on inflows eased to a greater extent than on outflows. It concludes that a more balanced liberalization process will sustain progress in renminbi internationalization. JEL Classification Numbers: E61, F33, F36, O11, O19 Keywords: capital controls, offshore financial markets Authors’ E-Mail Address: rcraig@imf.org; changchun.hua@nomura.com; phtng@hkma.gov.hk; rsyyuen@hkma.gov.hk This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate