China cracks the door on a global renminbi

The symbolism of currency swap agreements between China and the UK is highly significant, and under Beijing's new leadership it seems the renminbi's full internationalisation is only a matter of time.

China’s new political leadership is more modern, better educated and trained, and internationally experienced than any previous group on the all-powerful Standing Committee of the Communist Party.

While it is early days, there is much talk and high expectations in China that market-oriented and liberal economic reforms will be given fresh momentum by the new leadership group. Following the Party’s personnel changes last November, the state changes will be announced in March during the annual 'twin' meetings of the National People’s Congress and the Chinese People's Political Consultative Conference, which open on March 5 and March 3 respectively.

When these meetings are concluded, the government and bureaucracy will settle down to normal work and policy development and implementation. Policy ideas will be discussed and aired at academic symposia and through backgrounding of the media.

Expect to hear a lot on economic reform at that time. It is customary that at the Third Plenum of the Communist Party, expected to be held in October/November this year, for a major economic statement to be made. It was at the Third Plenary in 1979 that Deng Xiaoping unveiled the agricultural reform program and again, in 1984, extended reform to the urban areas of the economy.

Those close to the policy process are confident that the Third Plenary will launch a major series of reforms to China’s financial system, including capital account reforms to support renminbi internationalisation, or using the renminbi as a convertible currency. Rumours that the strongly reform-minded Governor of the People’s Bank of China (the central bank) is to have his term extended for two years beyond the mandatory retirement age of 65 suggests that key personal are being put or kept in place to drive financial sector reform.

As with earlier periods of major economic reforms, much has already preceded formal policy announcements as experiments and cautious incremental steps are taken.

London has just announced that it has agreed on currency swap arrangements with Beijing. Some 20 countries, including Australia, now have such arrangements in place. But in London’s case, the decision and announcement have been accompanied by much public fanfare that London aims to join Hong Kong as a major offshore renminbi trading centre. The swap arrangements are to facilitate trade and investment flows between China and the UK.

But the symbolism is perhaps the most important immediate effect of London’s decision: it gives a stamp of legitimacy to trading in renminbi. As part of its efforts to promote London as a centre for renminbi trading, last year the UK Treasury also approved the issuing of renminbi-denominated bonds – known as "dim sum” bonds – by the China Construction Bank.

The Chinese government’s policy of gradually internationalising the use of the renminbi is often misunderstood. China does not have ambitions to become a global reserve currency, let alone displace the US dollar from that role. Not only would this be impracticable in anything other than the very long run, but as with most other areas China eschews taking global responsibilities and leadership roles. The long-standing policy of keeping your head down and getting on with developing the economy still runs deep.

Internationalisation of the renminbi is not new. It started in Hong Kong nine years ago. Renminbi deposits in Hong Kong have built up rapidly and the renminbi is all but a quasi-convertible currency there. Hong Kong and more recently Taiwan have been designated as offshore clearing centres for the renminbi. On February 5, PBoC approved the Singapore branch of China’s Industrial and Commercial Bank to also perform this function. Clearing banks allow for direct transfers of funds to the mainland, without first having to use Hong Kong banks.

According to the China Daily, by December last year renminbi deposits in Hong Kong reached in excess of RMB600 billion, an 18 fold increase on five years ago and were RMB1.3 billion in Taiwan. On February 25, the Chicago Mercantile Exchange – owner of world’s biggest future exchange – announced that that it would begin selling RMB-denominated futures in Hong Kong.

For the renminbi to be widely used internationally, holdings of it overseas will need to increase substantially, this requires deeper and more liquid markets and confidence in its use. The rapid spread of swap arrangements and beginning of futures markets represent a very big step towards this.

But it will also require further reforms of the capital account and the gradual removal of the complex plethora of foreign exchange controls and restrictions that apply to businesses and individuals. Capital account reforms are underway – such as expanding the quotas for QFIIs – and more can be expected.

Complementary reform of the domestic banking sector will also be required in time and will in part be pulled along by external reforms: first a more widely used RMB in global trade settlements and then gradual liberalisation of the capital account with funds more easily moved in and out of China.

None of this will happen overnight. As with the history of the past 34 years of China’s reform and open door policies, the process is incremental but deliberate. Opening of this frontier of reform has begun. The new leadership has the experience and understanding of the issues to push this along harder.

For those of us who lived in China in the 80s and early 90s when two currencies circulated side by side, we thought that the ubiquitous Foreign Exchange Certificates used by foreigners, and anyone else who get their hands on them on the black market, were a permanent feature of China’s monetary and exchange systems. But in the end the FECs disappeared almost overnight. They lie in my sock draw alongside Italian lira and Greek drachma. It is more likely I’ll get to use the latter in Europe than the former in China.