A Chinese clerk counts US dollar notes next to RMB (renminbi) yuan notes at a bank in Nantong, east China's Jiangsu province, 14 October 2013. Photo: AAP
Before the renminbi (RMB) can challenge the dollar, China needs to develop its currency to be convertible under the flexible capital flows in and out of China. By internationalising RMB through offshore markets, China is able to introduce openness and transparency without fully liberalising its onshore market or open its capital account. This process has started in Asia and is spreading quickly to other parts of the world.
Asia needs a real alternative to the US dollar for intra-Asian trade and as a financing currency because the increasing integration of the global supply chain is bringing China and ASEAN closer together. Given China's position as the main driver of intra-Asia trade, RMB is a sensible option.
Bilateral trade between China and the Southeast Asian economic bloc reached a record high of US$400.9 billion in 2012, reflecting a year-on-year increase of 10.2 per cent. China is “near-sourcing” raw materials, components and finished products from within Asia like never before. Trade between these two huge markets will grow and invoicing it in RMB will benefit businesses on both sides. If a sizable proportion of an emerging-market country’s trade is with China, it makes sense to settle that trade in RMB rather than in dollars.
This is happening in Hong Kong. Cross-border trade settled in yuan increased 6.6 per cent in August to 304.2 billion yuan on a month-on-month basis according to the Hong Kong Monetary Authority. This helps Hong Kong generate the largest RMB liquidity pool outside mainland China. Taiwan and Singapore are catching up quickly after setting up clearing services earlier this year.
By 2020, intra-Asian trade will be worth USD10.8 trillion, almost double Asia’s trade with the rest of the world. This, combined with a secular reduction in overseas dollar payments as US consumer import demand declines and manufacturing returns onshore, will affect Asian trading and settlement patterns profoundly.
In currency terms, RMB will be the biggest beneficiary of this shift: we believe that by 2015, a third of China’s total trade and half of the trade between China and emerging markets will be settled in RMB.
Growing offshore use of RMB is not confined to Asia: Europe is in fact now the largest contributor to RMB payment growth. According to Swift, London now accounts for 28 per cent of offshore RMB settled transactions with China and Hong Kong, and RMB settlement has more than doubled in France, Germany and Luxembourg in the past year.
In order for a currency to achieve investment – and ultimately reserve – status, it has to create incentives for foreigners to trade and hold it.
It is worth pointing out that trading of the Chinese yuan in global foreign exchange markets has more than tripled from three years ago because of the expansion of the offshore market. Daily turnover in RMB has increased to US$120 billion from US$34 billion three years ago.
Dim sum bonds once excited issuers because they allowed foreign companies to raise RMB easily. Buyers found them attractive because they benefited from a rising currency and offered good returns. Their popularity waned during the summer months after the onshore funding rate spike in June and the uncertainty about when the US Federal Reserve will start cutting its stimulus programme. We believe these setbacks are temporary and cyclical phenomena, however. We already see new issuances coming back in September, led by multinational companies with operations in China.
China is already encouraging the development of RMB-denominated onshore assets for foreign investment. In China, cross border portfolio investment – purchasing bonds and equities – has to be conducted under limited quota schemes: the Qualified Foreign Institutional Investor (QFII) and RMB Qualified Foreign Institutional Investor (RQFII) for inward flows, and the Qualified Domestic Institutional Investor (QDII) scheme for outward flows.
Regulators have increased the quota for RQFII, which stands at 270 billion yuan (US$44 billion) and around half of that had been taken up by last month. The authorities almost doubled the quota of the QFII scheme to US$150 billion as Beijing moves to widen channels for foreign investors to buy mainland stocks, bonds and money market instruments. So far, US$46 billion flowed into the mainland under the QFII scheme.
According to the International Monetary Fund, rapid liberalisation of cross-border capital movements could produce over several years net outflows from China equal to 15 per cent of the country's Gross Domestic Product, or roughly US$1.35 trillion. Capital account liberalization may result in net outflows as the holders of China’s vast domestic savings pool seek diversification in overseas markets. This would increase global RMB liquidity, providing another boost to the currency’s internationalisation.
As China’s importance as a trading power increases, some central banks are – or planning to – include RMB in their reserve portfolios. Taiwan’s central bank has added RMB assets to its foreign reserves portfolio and the Reserve Bank of Australia intends to hold up to 5 per cent of its reserves in RMB assets. At the same time, the People’s Bank of China and the European Central Bank have a three-year bilateral currency swap agreement worth 350 billion yuan (US$57 billion) to provide further liquidity support for RMB use overseas. An additional 23 central banks and monetary authorities have signed similar arrangements.
Hong Kong has developed the largest RMB offshore liquidity pool and a range of investment products. The newly-established Shanghai Free Trade Zone can be another channel for Hong Kong to increase the flow of RMB back to the mainland. Hong Kong's pioneering work should benefit the next offshore centres, which – liquidity permitting – will be able to mature and deepen more rapidly.
China is now further internationalising its currency by encouraging the development of multiple offshore centres, not only Hong Kong, Taiwan, Singapore and London. Others such as Toronto, Luxembourg, Zurich, Paris, Frankfurt and even Sydney are quickly catching up and will help the RMB grow.
International currencies should have three basic characteristics: convertibility; broad acceptance; and wide use in various areas of international trade, settlement, investment, debt payment; and stable value. RMB is now broadly convertible on the current account and restrictions on the capital account are being loosened; it is rapidly becoming not just acceptable but desirable in the mercantile capitals of the global economy; and although it is not widely used today, it is showing every sign of being the currency of the future.
Candy Ho is the head of RMB Business Development, Asia-Pacific, HSBC