The Internationalization of the Renminbi
For many years now the Chinese government has carefully controlled its currency, tying its value to the US dollar to ensure currency risk is well managed. Many other emerging economies with open currencies have seen their economies wrecked by sudden devaluations aganist the dollar. The 1998 Asian crisis stands as a warning from history, currencies like the Indonesian Rupiah and Thai Baht depreciating rapidly to unleash economic chaos at home, then spreading like a virus to damage the entire region.
For many years it suited economic policy makers in Beijing to keep the Yuan undervalued, as well as protecting the currency from speculation it helped ensure Chinese exports were kept competitive, a central plank of the country’s mercantilist economic model (and giving China an unfair trading advantage according to many commentators). But as the Chinese economy matures and grows the government is slowly liberalising its currency with the aim of the RMB becoming a fully convertible currency.
A note on names:
Thought the Chinese currency was called the Renminbi, prefixed to the RMB, or perhaps the Yuan? Well on a trading floor (in Hong Kong) it’s a CNH, unless it’s onshore (Shanghai) when its CNY. Confusing yes, but then Chinese financial matters are rarely straightforward.
Time line Chart
2009 RMB Internationalisation begins
2010 Offshore markets start in Hong Kong
2012 Chinese companies start using RMB for trade finance
2013 Chinese RMB trade stands at 8% of currency trade
Over CNY 270 billion in bonds are issued (Dim Sum bonds)
RMB bank deposits hit ~ RMB 100 billion in Hong Kong
2015 Estimated that 1/3 of all Chinese trade will be settled in RMB & will become third most traded currency in the world after Euro and Dollar
2017/18 RMB to become fully convertible currency and Shanghai is on its way to being a truly global financial centre.
Cross the river by feeling the stones
As a first step the Chinese government floated the RMB against a basket of currencies, (but still ensuring it was managed, so did not fall or rise too high or low), over time trade with other primarily developing countries such as Russia and India can be increasingly completed in RMB. For many (like Russia) there is an added bonus of undermining the US dollar for geo-political reasons.
For the currency to become fully international, Beijing would have to fully liberalise the capital account, allowing Chinese businesses and people to invest abroad freely, this is unlikely to happen for some time, given the Chinese government are unlikely to be in favour of relinquishing a key lever of economic control. For now there is an offshore designation of the RMB – its symbol is CNH, separate from the onshore market designation CNY.
International payments are rapidly increasing in the currency, but still represent less than 1% of the global total in international flows and well behind the Yen, Pound and of course the Euro and the Dollar. This is changing rapidly with HSBC predicting that it will be the third most traded currency by the end of 2015.
The long and winding road to convertibility…..
The final remaining ingredient needed before the RMB is fully accepted as an international currency is that China will have to get over its current (perceived) economic problems and become, or at least well on the way to becoming a “developed” economy which would include more transparent financial governance. Even if the currency becomes convertible (fully exchangeable without restrictions) that does not mean it will become truly international. No currency has truly challenged the US dollar for 70 years, but the Chinese “Redback” could have a chance, given the size of US debt and the growth of the Chinese economy. For now a realistic proposition is for it it become another reserve currency alongside the Euro and put it in a position to one day displace the US dollar as the world’s premier currency. For that to happen a major realignment in the world economy would have to occur involving a major blow to US hegemony, which is difficult to forsee, but not impossible.
Where are the Opportunities?
Whether or not the Renminbi becomes truly international or challenges the Greenback is a matter for economists and fortune tellers, but what is crucial for now is that there are interesting opportunities for outsiders to capitalise on the currency’s transition to convertibility.
Investments in a new asset class – companies can invest in “dim sum” bonds, renminbi commodity funds and renminbi ETFs (exchange-traded funds), knowledge and use of these by early adopters will create expertise which will be invaluable as the asset class grows in value and importance.
Trade finance: China is the lynchpin of trade in Asia and across emerging markets, so it makes sense for trade to be settled between say Thailand and China in RMB, rather than the US dollar. Standard Chartered Bank estimates that 15% of trade with China will be settled in RMB by 2015. HSBC estimated in 2013 that Chinese firms were able to offer improved terms on trade settled in CNH compared to other currencies. But most firms have not yet got the facility to use the currency, but banks in London, Luxembourg and Hong Kong will be falling over themselves to open accounts in offshore CNH. If you are involved in trade or settlementments you should be looking into the possibilities of using RMB before others do it and you are left trailing in their wake.
Dim Sum – not just for eating
Since the Hong Kong authorities gave permission, foreign entities have been able to issue dim sum bonds in Hong Kong and in 2012 HSBC issued the first offshore RMB bond in London. Singapore and Taiwan are also set to become centres for offshore issuance. The catch is that funds cannot be automatically sent into China (it will remain a one way door for funds in most respects).
Offshore CNH can be used to raise bonds and issue loans, providing financing for companies, giving an opportunity to reduce currency risk, but also managing cross border flows to and from China – avoiding the issue of cash being trapped there.
Banks and financial institutions will be able to use offshore CNH to diversify their cash/portfolio holdings and become involved in the CNH foreign exchange market at its early stages. The offshore market – as more RMB funds flow offshore they can be used abroad (still small but expected to grow rapidly), this recycling of funds will allow this sector to grow rapidly. Further liberalization of the capital account will release upward pressure on the RMB, but also allow Chinese finance to flow outwards – more necessary than ever as Chinese private companies look to buy more foreign companies
London, Taipei, Hong Kong, Luxembourg or Frankfurt, which city will dominate global RMB flows?
The competition between these four financial centres will soon determine who will dominate the soon to be considerable business of managing, recycling and converting RMB offshore flows. Hong Kong has a massive head start thanks to its long term usage of the currency and because it is in the same country, albeit a different legal regime, however usage in Taipei is picking up fast and complacency on Hong Kong’s part could see them lose market share. In Europe Luxembourg took an early adoption strategy and has many Chinese banks present which use the city state as their European headquarters which will give them a good long term advantage, but it will face fierce competition from Frankfurt and London as they realised very quickly the potential for money making around the Yuan.