Over the last decade, the renminbi has gone from being unknown outside China to being the fifth most traded currency and the second most used currency for trade finance in the world. Bruce Andrews asks where this journey will lead us next – is the renminbi destined to become a global reserve currency?
The renminbi’s first steps on its path towards internationalisation were marked by difficult economic circumstances and a tragedy, followed by a sympathetic gesture. In 2003, Hong Kong’s economy had suffered a crippling double-hit from the global ‘dot-com’ stock market crash and then the outbreak of Severe Acute Respiratory Syndrome (SARS). To give the city’s economy a much-needed boost, Chinese authorities in February 2004 announced they would permit personal banking to be conducted in renminbi in Hong Kong.
China has certainly also benefited from opening its currency up to the world. Moreover, it has been an important step in the country’s economic development over the past 10 years. As Rongrong Huo, HSBC’s Head of China and Renminbi Business Development, Capital Financing, Global Banking and Markets, explained in a short film produced by her bank on renminbi (www.youtube.com/watch?v=Tha-S7TR3gs), China was a closed country where everything was regulated until the early 2000s, particularly money. Before the controls on the currency began to be relaxed, goods and services were heavily rationed.
‘The opening up of the currency has changed people’s lives here, and the most exciting thing is that it is only the beginning,’ says Ms Huo.
So what is meant by the phrase, ‘the internationalisation of renminbi’? Essentially, it means allowing the Chinese currency to be used outside the Mainland, allowing renminbi to be used for payments, settlements, investments, financing and potential reserves management.
Some of the preconditions for the currency’s internationalisation are already satisfied. However, free convertibility under capital account market-orientated liberalisation and opening up the onshore capital markets are requisites that are yet to be achieved before the renminbi can become completely internationalised. Though the most recent announcements from Chinese leaders indicate that the overall reform will accelerate.
A remarkable journey
Before 2004, we rarely saw the renminbi being used outside China. With the introduction of personal renminbi business in Hong Kong, yuan cash notes could be funnelled from Hong Kong back to the Mainland through the banking system. The onshore renminbi market, with currency trades at exchange rates controlled by the government, remained the only marketplace for the Chinese currency. However, a turning point came in 2010 when Chinese and Hong Kong authorities launched an offshore renminbi market (CNH). The major difference was the offshore CNH yuan exchange rate was floating and predominantly determined by private demand for the currency.
Since then, the number of offshore renminbi markets around the world has grown steadily with London, Singapore, Taiwan, Germany, Canada and many others allowing renminbi clearance banks at their locations, making it easier for overseas businesses to participate. Also from 2010, foreign companies have been able to issue renminbi-denominated ‘dim sum’ bonds outside China to fulfil their financing needs.
At the close of 2014, the renminbi ranked fifth as the most traded currency in the world, according to the Society for Worldwide Interbank Financial Telecommunication (SWIFT), at 2.2% of SWIFT payment. The currency only trails the US dollar (44.6%), the euro (28.3%), the British pound (7.9%) and the Japanese yen (2.7%).
This is a notable result for the currency, as the renminbi was in eighth position in 2013 and seventh in early 2014 for most traded currencies in the world. In February 2015, the renminbi was also the second-most used currency in trade financing and ninth in the world for foreign exchange trading. In August 2014, more than 10,000 financial institutions were doing business in renminbi, up from 900 in June 2011; moreover, about 18% of China’s trade is settled in its own currency, up from only 3% in 2010. There are now eight official offshore renminbi trading centres around the world: Hong Kong, Macau, Taiwan, Singapore, London, Germany, South Korea and Toronto (which signed in November 2014).
In an interview with CSj, Ms Huo says the internationalisation process of the renminbi and its progress towards full convertibility has been truly impressive but it is a journey that has only just started. She emphasises that the currency reforms to date are just one aspect of China’s integration with the rest of the world. While the development of China’s onshore capital market has been crucial in its economic transformation, there is more work to be done in opening strategic capital flows with the rest of the world, particularly outward direct investment (ODI).
While trade settlement in the renminbi has certainly expanded substantially in recent years, Ms Huo expects in 2015 that the Chinese currency will continue to become more market-orientated and used more widely for global payments, financial investments, financing and reserve management. ‘Beijing’s commitment to speeding up capital account liberalisation implies that full renminbi convertibility may come earlier than many expect, and is likely to be in the next two or three years,’ she says.
Meanwhile, running in parallel to the currency’s shift to full convertibility, she anticipates that more financial reforms will be rolled out for both onshore equities and fixed income development (primary and secondary market) within the Mainland.
This year, China’s economic growth has been forecast by Beijing to decelerate to 7%, down from 7.4% in 2014. Ms Huo remains positive and believes we will continue to see the progress in
the renminbi’s internationalisation for several reasons.
- China’s economic growth ‘is transforming from quantity to quality to achieve sustainable growth’, she says. She adds that 7% growth is still very high in comparison with other countries, especially when looking at the size of China’s gross domestic product (GDP) in relation to global GDP.
- China’s central bank – the People’s Bank of China (PBoC) – has stated it will not intentionally create a stronger or weaker currency, as it would go against the central government’s commitment to economic rebalancing and structural reform.
- According to the latest government work report discussed in China’s National People’s Congress held in Beijing in March 2015, the central government is committed to continue to support market-oriented development.
- The current cross-border capital flow via schemes such as the RMB Qualified Foreign Institutional Investors scheme (RQFII), is very much around securities investment within the secondary market, such as investing in Chinese equities and bonds onshore. The market desires to see more in the primary market – a key focus area for the renminbi’s internationalisation in 2015 and onward will be centred on strategic capital flow, such as ODI – which is also in line with the ‘One belt, one road’ strategy of China’s national plan. This development strategy was initiated by China’s central government in 2013. It refers to the new Silk Road economic belt, which will link China with Europe through Central and Western Asia, and the ’21st century maritime Silk Road’, which will connect China with Southeast Asian countries, Africa and Europe. ‘ODI will hopefully generate round-trip renminbi transactions that (according to HSBC research) will not have to depend on renminbi appreciation to be attractive,’ Ms Huo says.
The journey of the renminbi towards full convertibility with the world’s other currencies has been carefully managed by the Chinese central government. This conservative approach has been substantially due to concerns over the risks of a situation occurring where ‘hot money’ flows too quickly in and out of the domestic economy, which potentially could destabilise China’s financial and currency exchange markets. Typically, ‘hot money’ (the flow of funds between one country and another in order to earn profits in the short term) is used speculatively to take advantage of interest rate differences or anticipated shifts in exchange rates, and is moved very quickly in and out of markets.
‘The Chinese government has been very proactive in managing the risks of hot money by using a quota- and licence-based system – such as the RQFII,’ Ms Huo says. ‘They have gradually relaxed the rules and increased quotas over time, which has helped ease the approval process [for financial institutions and investors] while managing the issues and gathering feedback along the way.’
China’s overall strategy has been to encourage investors with long-term aims to be the first to enter its capital markets, such as overseas central banks, insurance companies and pension funds. As the renminbi’s foreign exchange mechanism has become more market orientated and the onshore capital markets have gradually opened up to the world, there has been convergence between offshore and onshore yields, such as the yields for offshore sovereign and non-bank credit, which surpassed onshore levels for the first time in March 2015, Ms Huo says.
‘Renminbi internationalisation is, and will always be, implemented cautiously with the aim to roll out nationally if successful,’ she says. ‘For example, the Shanghai Free Trade Zone was set up [in 2013] as a pilot [programme] for a basket of capital-account convertibility activities, and it will be rolled out nationwide if successful.’
The Shanghai Free Trade Zone has been utilised as a laboratory for Chinese authorities to test many reforms as the currency heads towards full convertibility, said Caroline Owen, Regional Head of RMB Solutions at Standard Chartered Bank, in a televised interview. ‘It is important that they use this controlled environment to test the changes so they can review the results of these changes and make changes before rolling them out to the rest of the country,’ she said.
Ms Huo says she expects the opening up of China’s onshore capital market will continue to be done systematically and in a step-by-step manner, ‘from introducing quota systems to the ongoing monitoring and adjustments, and then by adding more channels such as the Shanghai-Hong Kong Stock Connect,’ she says. She adds that the stock connect link between Shanghai and Hong Kong (which will soon extend to Shenzhen) is a transformational process which will lead to further developments such as opening links for commodities, bonds and cross-border listing ETFs trading.
The Shanghai-Hong Kong Stock Connect pilot programme, launched in November 2014, has excited many observers with the possibilities it offers for offshore investors with renminbi deposits. While the scheme has linked the Shanghai and Hong Kong stock exchanges, allowing overseas investors to purchase approved shares in companies listed on Shanghai’s stock exchange, it promises to provide the blueprint for more channels to the Mainland’s capital markets to become available. In January this year, China’s Premier Li Keqiang announced a second Stock Connect to bridge the Shenzhen and Hong Kong stock exchanges, and many expect more channels linking the interbank credit, bonds, futures and commodities markets to open soon after.
‘[The Shanghai-Hong Kong Stock Connect] will help increase overseas usage of the yuan and cross-border transactions in yuan, as well as boost the offshore renminbi market. This will, in turn, accelerate the yuan’s internationalisation,’ said Jiang Licheng, Managing Director, Retail and Brokerage, BOC International, in a recent televised interview.
Ms Huo points out that ‘building on the Qualified Institutional Investor (QFII and RQFII) programmes, the Shanghai-Hong Kong Stock Connect provides a platform providing access to investors in order for [more] capital to flow into and out of China with all the necessary market infrastructure. With the backdrop of China’s journey of financial and capital reform, we will see wider channels for capital to flow, and [refinements in] the renminbi settlement mechanism will promote renminbi usage as an investment currency, which will in turn facilitate better renminbi liquidity, create market demand in both the primary and secondary markets, and will help the long-term goal to achieve onshore/offshore convergence.’
Companies outside China would do well, she advises, to understand how China will be pursuing links with the rest of the world along certain themes, such as ‘global sustainable financing’, ‘building infrastructure’, and so on. They will also need to realise the new opportunities that are likely to arise out of China, such as substantial increases in ODI. China’s rapidly growing ODI is expected to soon exceed Foreign Direct Investment (FDI) into the country and for China to become the second-largest net global investor, according to HSBC research, Huo says (see ‘China FDI and ODI’ opposite).
Finally, Ms Huo expects to see more offshore renminbi centres and bilateral swap lines developed as China continues to facilitate the offshore liquidity of its currency and build strategic engagement with those centres.
For instance, on 23 March 2015, ICBC Canada was officially launched as a renminbi clearing bank, and Toronto as the first renminbi trading hub in the Western hemisphere. It joins 12 other locations around the world with appointed renminbi clearing banks – these are: Hong Kong, the UK, Germany, France, Singapore, Malaysia, Taiwan, South Korea, Thailand, Australia, Luxembourg and Qatar. In January this year, the Swiss central bank announced it had agreed with the PBoC to establish clearing arrangements in Switzerland for renminbi trading and to extend a pilot scheme for Swiss investors.
Global reserve currency?
Looking further into the future, while China is aiming for the renminbi to be a major trade and investment currency, there is also an ambition for the renminbi to become the second global reserve currency, next to the US dollar, within 15 years. While there is certainly an appetite for investors and central banks around the world to diversify their currency holdings, there is much work to be done in order for the renminbi to attain this status.
In a televised interview for the Asian Development Bank, Barry Eichengreen, Professor of Economics and Political Science at the University of California, Berkeley, outlined that there are three prerequisites for the renminbi to become a global reserve currency: scale, stability and liquidity.
‘Scale means if you are going to be the issuer of a true international currency, you have to be a big country that engages in a lot of international transactions. China qualifies now, and it will qualify even more in the future,’ he said. ‘Stability means economic, financial and political stability. A currency is attractive if there are stable economic policies and stable financial markets standing behind it. China increasingly satisfies that prerequisite. To my mind, [liquidity] is the hard one. Building deep and liquid financial markets takes time. It requires building infrastructure [and] it is a process that only a few countries have completed.’
It could also be argued that China will not only need to prove the strength of its financial markets and the depth of the currency’s liquidity, it will have to win the world’s trust to become a global reserve currency. Doubtless, these are all daunting challenges, but China believes they are surmountable.
Bruce Andrews, Journalist
SIDEBAR: Major milestones for renminbi business in Hong Kong
Hong Kong banks begin to be allowed to accept renminbi deposits and other renminbi banking services, such as currency exchange and remittances in small amounts.
Qualified Mainland financial institutions are permitted to issue renminbi (‘dim sum’) bonds in Hong Kong. Renminbi deposits in Hong Kong increase substantially as a result, and the renminbi is no longer confined to the retail level as it now also includes capital investing.
A trial scheme is launched for 365 enterprises in five Mainland cities – Shanghai, Shenzhen, Zhuhai, Dongguan and Guangzhou – to start cross-border renminbi trade settlements with partners in Hong Kong, Macau, Taiwan and ASEAN countries.
The restriction on non-financial companies issuing dim sum bonds in Hong Kong is relaxed. In September 2010, McDonald’s becomes the first foreign non-financial company to issue a ‘dim sum’ bond.
The People’s Bank of China (PBoC) and the Hong Kong Monetary Authority (HKMA) sign a new agreement permitting free flow of renminbi between individual and enterprise accounts, and allow for a wider range of renminbi transactions to be conducted.
The PBoC and Bank of China (Hong Kong) sign a revised settlement agreement for the first offshore interbank market for renminbi to develop in Hong Kong.
The renminbi trade settlement pilot scheme is extended to cover all provinces in Mainland China.
The Renminbi Qualified Foreign Institutional Investor (RQFII) scheme is introduced, enabling overseas investors to use offshore renminbi deposits in Hong Kong to invest in Mainland securities markets.
The RQFII scheme is expanded to include all financial institutions that are registered and have major operations in Hong Kong.
The renminbi overtakes the euro as the world’s second most-used currency for trade finance after the US dollar, according to the Society for Worldwide Interbank Financial Telecommunication (SWIFT).
The Treasury Markets Association launches the fixing of the benchmark renminbi Hong Kong Interbank Offered Rate (‘CNH HIBOR’).
The Shanghai-Hong Kong Stock Connect pilot programme is launched, allowing qualified Mainland Chinese and Hong Kong investors to trade eligible shares listed on each other’s stock markets through local securities firms.
In January, Switzerland becomes the eighth jurisdiction to be included in the RQFII scheme. In addition to Hong Kong and Switzerland, the other jurisdictions that have been allocated RQFII quotas are the UK, Singapore, France, South Korea, Germany and Canada. The combined approved RQFII quotas total approximately RMB820 billion.
Chinese Premier Li Keqiang announces a second Stock Connect linking the Shenzhen and Hong Kong exchanges.