One of the most interesting, and potentially far-reaching, developments since the financial crisis has been the internationalisation of China’s currency, the renminbi, which is now regarded as the fastest growing currency in the world.
Until 2009, when China created a modest trial for the use of the renminbi in cross-border trade, Beijing had maintained very tight controls over the currency with very limited exchangeability to maintain control of its value as well as the regime’s control of its domestic financial settings.
What’s happened since then has been remarkable. An HSBC report on the ‘’rise of the redback’’ this month said there are now 10,000 financial institutions doing business in renminbi, the pool of offshore renminbi is now around $US143 billion and the proportion of China’s exports and imports settled in the currency is now almost 12 per cent.
Renminbi cross-border capital flows are surging, with renminbi foreign direct investment tripling last year and outward renminbi investment rising about 50 per cent as China adds an investment dimension to the currency’s growing use in trade settlement.
HSBC has projected that a third of China’s total trade will be settled in renminbi by 2015, making it one of the top three global trade settlement currencies by volume. It is predicting, with some qualifications, that the renminbi will be fully convertible within five years.
That’s not dissimilar to the conclusions of a US Congress committee that warned the renminbi might be able to challenge the US dollar as a reserve currency within five to 10 years.
China’s newly refreshed leadership is committed to continuing renminbi liberalisation, albeit in a controlled and progressive process to limit risk and volatility and the impacts of liberalisation on its domestic markets and economy if it moves too quickly.
There are some obvious benefits, not just in terms of prestige and global clout, but in practical terms from greater acceptance of the renminbi in global trade and investment flows.
It removes foreign exchange risks and costs for Chinese entities and provides access to a far greater pool of private capital at a potentially lower cost to fund its economic development and growth. It could also bring greater markets-driven disciplines to the allocation of capital within China and by Chinese entities offshore, as well as help in the development and growth of China’s domestic financial markets and institutions.
China has established offshore renminbi centres in Hong Kong, London, Singapore and Taiwan, has currency swap arrangements with about 20 foreign central banks, and has been progressively, albeit cautiously, opening up its capital account to investment flows.
There have been some reforms of its domestic markets and institutions and it has given its banks more flexibility in pricing credit, a precursor to greater liberalisation of financial institutions that is necessary to establish a properly functioning and liquid bond market.
Deep and liquid financial markets, light (at worst) restrictions on capital flows and a credible legal framework are pre-requisites if the renminbi is ever to be regarded as a reserve currency, although it is interesting, but not surprising given trade flows, that acceptance of the renminbi has been particularly pronounced within Asia. HSBC believes that emerging markets generally will settle in renminbi as their trading relationships with China expand.
It is improbable that China will completely, or even largely deregulate its capital accounts and relinquish control over the value of its currency and key domestic financial levers, any time soon.
It is, however, at least conceivable that as its economic and political influence continues to grow that the ‘’redback’’ could challenge the euro as an alternate reserve currency to the US dollar and perhaps, in the longer term provide a real alternative to the greenback and share its dominance of the world’s foreign exchange transactions, commodity pricing and central bank and government reserves.
As HSBC noted, that would have profound implications for the world’s financial system and the global economy – much as China’s rise as an economic power already has. It might also have some impact on geopolitics.
It would certainly mean quite fundamental and liberating changes for China’s domestic economy and its political and social frameworks, which is why the authorities are hastening slowly.