Yuan likely to appreciate against USD in 2013

Hong Kong banks are increasingly offering attractive renminbi (or yuan) deposit rates, which I expect to remain stable in the near term. I also see some scope for appreciation in both the offshore and onshore renminbi against the dollar in 2013.

Offshore renminbi deposits in Hong Kong offer a new option for investors who seek higher yields but are not willing to take on excessive exchange-rate risk. Yuan deposit rates in Hong Kong have increased by over 2.3 percentage points since late 2011 to the current 3-3.2 percent, depending on term of deposit.

Hong Kong residents can buy up to 20,000 yuan of deposits a day. Non-Hong Kong residents, or individuals without a Hong Kong identity card, were recently permitted by the Hong Kong Monetary Authority to open local bank accounts without any daily yuan conversion limits.

Yuan deposit rates in Hong Kong have in past years been well below the onshore one-year benchmark rate, which now stands at 3 percent after two 25 basis-point cuts over the summer. These offshore and onshore rates have now converged following a drastic swing in exchange rate expectations from appreciation to depreciation, especially against the US dollar. As demand for yuan conversion stalled, Hong Kong banks increasingly sought to tempt savers with higher rates.

Looking ahead, the CNY (onshore Chinese yuan exchange rate) and CNH (Hong Kong yuan exchange rate) are expected to stay relatively stable for the rest of the year, and to appreciate by about 1.5 percent against the dollar in 2013. I don't expect a significant move either higher or lower over this period, although two-way volatility may increase in the longer term.

Several factors caused the Chinese currency to fall 1.4 percent against the dollar between May and June, with expectations of a continued slide. The worsening Euro zone debt crisis, a sharp decline in Chinese export growth to just 1 percent in July, and reduced foreign direct investment into China all led to capital outflows. These outflows pushed China into its first (though moderate) second-quarter capital and financial account deficit in a decade.

The recent renewal of strong support from global central banks, notably the US Federal Reserve (Fed) and European Central Bank, appears to have increased risk appetite and slowed the capital outflow from China. Further helped by intervention by the People's Bank of China, the CNY is now little changed from the start of the year.

The yuan is expected to remain stable for the rest of the year, especially during the period of political leadership transition in early November.

In the medium term, I believe the quantitative easing by the Fed (QE3) will lead to some pick-up in Chinese exports and a modest recovery in Chinese growth which may support a 1.5 percent gain of the CNY and the CNH against the dollar in 2013.