The ramifications of redback reform

Expanded use of the RMB will have profound economic implications for its major trading partners such as Australia.

The Chinese Government is rolling out a sequence of reforms designed to increase the use of its currency, the renminbi (RMB) in international trade and investment. Establishing RMB settlement hubs in major financial centres outside of China and reducing restrictions on cross boarder capital flows are focal points of this initiative.

Expanded use of the RMB and the carefully sequenced opening of China’s capital account will integrate China as a key player in global capital markets and have profound economic implications for its major trading partners such as Australia.

China’s economic size, diversified trade and high growth economy mean the RMB has the potential to become one of the world’s most widely used currencies by 2020.

As an established global economic power however, the country’s economic might has not yet been matched by its global financial integration.

This will not persist in the long run, as the Chinese authorities are committed to a liberalisation process and have already taken a number of important deregulatory and market-oriented steps as it pursues the long run goal of achieving high-income status for the Chinese economy by 2020.

Australia has generally been well positioned in leveraging these new opportunities with government, corporates and financial institutions proactively responding to this process of change.

Australia is now at a positive tipping point in its relationship with China. The signing of a bilateral local currency swap agreement between the Reserve Bank of Australia (RBA) and the People's Bank of China (PBOC) in March 2012; the achievement of direct trade between the currencies in April 2013; the RBA beginning to hold RMB reserves and Chinese government debt; and the Australian Securities Exchange (ASX)-Bank of China RMB settlement service, which was instituted in February this year, have all contributed to furthering financial ties between the two economies who are so closely related in the real sector.

The speed of RMB internationalisation will be led by its increasing adoption as a trade currency. Since December 2013, it has been the world’s second most used trade currency. Invoicing and trade settlement denominated in RMB has been steadily increasing in recent years. As of the first quarter of 2014, 18 per cent of China’s trade was denominated in RMB, this is expected to rise to 30 per cent by 2015.

However, trade related flows alone will not be enough to achieve this outcome. Diversified cross holdings of Chinese assets abroad and foreign assets in China must develop if these projections are to be reached

Based on these observations, as well as the establishment of offshore RMB hubs in strategic financial centres, various onshore financial market reforms and increased avenues for cross border use of RMB for trade and investment activities, Westpac believes that the following will occur by 2020:

  1. Opening of the capital account: Banking related transactions (loans, deposits, and derivatives) will flow freely in both directions. Investment related activities including Chinese Corporate’s overseas investment and acquisition are expected to increase significantly. In order, inward institutional portfolio flows will progressively be increased with outward flows not far behind, and outward household portfolio investment is expected to be relaxed thereafter.
  2. Liberalisation of interest rates: The final frontier regarding interest rate deregulation is to allow the deposit rate to be set by market forces. Lending rates are already largely market determined, but deposits are constrained to be no more than 1.1 times the regulatory ceiling. Complementary reforms of deposit insurance and the legislative loan-to-deposit ceiling are likely pre/co-requisites for deposit rate deregulation.
  3. Convergence between onshore (CNY) and offshore markets (CNH): RMB will be broadly fungible and the role of offshore RMB hubs will evolve as capital flows become denominated in CNY.
  4. RMB will be on an even footing with other global currencies: the RMB cross-border payment clearing system China International Payment System (CIPS) will ensure global RMB liquidity and will have similar operating hours, risk reduction and liquidity optimisation to currencies such as the US Dollar, Euro and Pound Sterling.
  5. Significant progress towards establishing Shanghai as an international financial centre.
  6. RMB will be an international reserve currency and constitute a significant part of central bank foreign reserves.
  7. Establishment of a sound legal system: The Chinese government has noted the significant efforts they have put in to controlling corruption and establishing a ‘clean’ government. A prerequisite for successful financial reform is having a law-based government under the rule of law operating within a transparent execution system. As China has committed to a sophisticated financial system by 2020, operating within a sound legal system is recognised as pivotal for financial reform and development.
  8. Simplification of approvals: A well-established market is expected to be developed through the simplification of government approvals and approving processes. This will make China a more attractive destination for investment and help create a more business-friendly environment.

Despite these significant changes on the horizon, at present very few Australian businesses actually invoice and settle trade in RMB.

Many corporates may be aware that there could be benefits available from direct RMB payments, but for a number of reasons these are not being captured.

Westpac anticipates that momentum in Australia will follow a similar accent as other offshore RMB settlement hubs around the world such as Singapore and London, as larger pools of liquidity, trade and transactional flows have encouraged confidence and further market activity.

Until this happens, Australia isn’t necessarily going to see advantages of direct transactions with the RMB straight away. Years of familiarity dealing with the US dollar are unlikely to be replaced overnight. Many businesses prefer the certainty of the familiar over the promises of the new. Others may be uncertain about their ability to negotiate discounts and settlement terms to reduce operating costs – with flow-on effects to working capital management.

Andrew Whitford is the Head of Greater China for Westpac. He will be a panellist at the 2014 Sydney China Business Forum focusing on 'Australia-China Partnerships in Financial Services' in Sydney on Monday 17 November, which is open to the business, government and academia community.

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