Some Thoughts on Foreign Currency Time Deposits

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A friend asked me this question:
What is your view of RMB time deposit offered by bank of china? The offer is found here.

My answer is: Dear Mr. A,

I had a brief look at what the offer is. I can't say I know too much about currencies and of this specific deal. And what I am about to say, might be factors that might be already obvious to you. But here goes:

You are taking on 2 main exposures by doing it. 

First, currency exposure, i.e. the fluctuation of the RMB versus your home currency (I presume you are thinking of changing SGD to RMB, but it could also be USD/RMB or some other currency pair). 

The appreciation or depreciation of a foreign currency depends on a few factors, which are affected by macro-economic policies which might be unforeseeable, and also the relative strength of the 2 economies, their interest rate differential and their inflation rate differential (this is actually Fisher's interest rate parity theorem). And of course if the current pricing is inefficient, then there are also sentiment driven factors. But let's assume the currency market is efficient (in the parlance, we'd call that the null hypothesis), which it likely is, since the currency market is one of the most liquid, if not the most liquid market in the world. 

Where any of these factors are going, and the relative strength of it versus Singapore is hard to predict, and the interaction of the factors are complex. So, you have to ask yourself whether you believe that the RMB is going to appreciate against the SGD. If it depreciates instead, it could offset the yield that you were getting from the RMB time deposit.

Disclosure: My experience in forex is limited, I have used currency swaps structured similar to forex time deposits before, as I was posted aboard for a period, and of course the usual forex transactions when travelling. I currently have no direct or derivative positions on forex but have foreign asset holdings denominated in foreign currencies and some tiny amounts of paper currencies.

Interest rate exposure is the next factor. If the interest rate rises, you would have "paid" opportunity cost in locking in your money. This applies regardless whether it's a foreign currency deposit or a local one.

But the foreign currency element complicates the equation, since we are now talking about the relative interest rates between the 2 countries. Anyway, for this particular case, this factor is not so important for deciding whether to go into the RMB time deposit, but this factor would help you decide the tenure you wish to go for. 

If you think that interest rates are going to be remaining stagnant, or decreasing further, then you might wish to go for a longer tenure. However, interest rates are likely to rise, so you might want to choose a shorter tenure, and then rollover your RMB upon expiration of that time deposit. Once again, in this case, the relative interest rates (and not the absolute) must also be considered. You can think of interest payments as the opportunity cost of money.

In my opinion, such plays are great if you have use for the alternate currency. Meaning, if you say go to China alot, or live there also, then this can be good since it gives you a chance to enjoy the higher yield while changing money.

Another thing to watch out for is what rate your SGD is exchanged at to RMB. It is not clear to me whether the rate you get here is the offshore RMB (known as CNH) or the rates they get in China (called CNY). So do ask the banker that, and the difference between the 2 rates. If it is CNH, then you have 1 more factor to consider. CNH trades at a premium to CNY. This premium could shrink or increase base on the demand and supply of the currency, which ultimately is driven by the economic and policy factors. Which are complex and might be impossible to forecast.

My last point is, if the bet you wish to make is on the appreciation of the currency, there are other instruments you can use, such as betting on a currency future, or using options, or just buying it on the spot market. This can offer you a very direct exposure and might be at much better rates and cheaper costs. You may wish to consult a trading house trading currency derivatives for these. 

More indirect bets include buying chinese assets instead, such as chinese stocks, or dimsum bonds, etc. These though are governed by other factors such as the valuation of the shares etc and yield curves, which I think is not what you are interested in.

So the deal while appearing vanilla has a certain level of complexity involved, and is not that straight-forward.