The internationalisation of the RMB is already underway and the potential is good but its convertibility is still a long way off.
Over the last three years, the Chinese authorities have stepped up initiatives to internationalise the renminbi (RMB) by establishing RMB currency swap agreements, by using the RMB as a currency for settling cross-border transactions, and through the development of a RMB offshore centre in Hong Kong. The RMB’s internationalisation is underway, but its convertibility is still a long way off.
An original approach by the Chinese authorities
China’s approach is original on two fronts. Firstly, it is internationalising the RMB from an offshore location (Hong Kong). Secondly, in a departure from past experience with the USD, the Deutsche Mark and the Yen, China has decided to internationalise the RMB ever before it is convertible. Its method is very prudent and gradual, involving several pilot schemes.
The direction being taken is clear: regionalisation first, then internationalisation. This involves promoting the settlement in RMB of commercial and financial transactions in Hong Kong, which already serves as a platform for Chinese exports, and subsequently using other financial markets in the region (Singapore) as RMB offshore centres.
The internationalisation of the RMB is already underway and the potential is good…
It was during the 2008 financial crisis that China’s central bank, People’s Bank of China (PBoC), established an “official” status for the RMB through a series of bilateral currency swap arrangements with central banks, essentially Asian. These agreements, for a total of USD130bn, allowed China to pay for its imports and bill its exports in RMB. The international exchange of a currency that is not convertible thus became possible. Parallel to the bilateral currency swap agreements, China contributed up to USD34bn to the 2009 expansion of the Chiang Mai Initiative that established a regional currency swap agreement between ASEAN countries, China, Japan and South Korea.
In 2009-2010, the PBoC launched several initiatives to promote the use of the RMB by the private sector. In July 2009, a pilot scheme was launched authorising the billing in RMB of commercial transactions between 5 authorised Chinese cities and Hong Kong, Macao, and ASEAN countries. In June 2010, this scheme was extended to 20 Chinese provinces for transactions with the rest of the world. The use of the RMB as a settlement currency for foreign transactions has progressed enormously: in April 2011, cross-border payments in RMB amounted to RMB540bn, and accounted for 5% of total transactions versus 2.5% in 2010. A large share of this RMB-denominated trade was carried out with Hong Kong and related to Chinese imports billed in RMB to foreign suppliers.
The internationalisation of the RMB has been more cautious in the area of financial transactions. In August 2010, foreign financial institutions were authorised to invest in the onshore interbank market but were subject to certain quotas. In January 2011, the PBoC launched a pilot scheme under which Chinese companies could make foreign direct investment in RMB.
RMB deposits in Hong Kong have grown dramatically since June 2010. In May 2011, they totalled USD80bn, representing 8% of bank deposits in Hong Kong versus 1% in 2010. These notably relate to companies that settle cross-border commercial transactions in RMB but also private individuals residing in Hong Kong.
Apart from its appeal as a placement/investment vehicle in Hong Kong given its upside potential, the RMB is also used as a means of financing. In the first half of 2011, CNH-denominated bonds (RMB convertible to Hong Kong) issued in Hong Kong (called Dim Sum bonds) amounted to USD9bn (versus a cumulative 12bn in the period 2005-2010). Issuance was mainly by financial institutions: large public Chinese banks and Hong Kong commercial banks present in continental China. China’s finance minister and major international companies (McDonalds and Caterpillar) have also issued on this market. The issuers of Dim Sum bonds seek to profit from lower interest rates in Hong Kong than in continental China. Ultimately, they hope to be able to use the CNH to invest in onshore RMB capital markets. The launch of a mini-scheme for qualified foreign institutional investors setting out a quota for CNH-denominated investment in onshore financial markets has been postponed several times due to fear on the part of the Chinese authorities of attracting too high a level of speculative short-term capital flows.
… but the lack of convertibility will limit its internationalisation
Recent developments have pointed to the successful “international” use of the RMB as a unit of account and method of payment, and indicate strong potential due to China’s growing commercial and financial integration in the global economy. However, the RMB’s use as an important international reserve remains limited.
It takes much longer and is more difficult to obtain the status of a reserve currency. For this, the currency must be held in sufficiently high quantities in the currency reserves of foreign central banks and international financial institutions. And this requires confidence in the financial markets of the issuing country and the convertibility of the currency in question (liberalisation of the capital account). As a first step, the use of the RMB as a currency peg (as part of a basket of currencies) by a country in the region could encourage central banks to hold RMB in their currency reserves.
The convertibility of the RMB, the final stage in its internationalisation process, remains therefore a long-term objective. The fact that the Chinese authorities want to make Shanghai an international financial market by 2020 suggests that the RMB will become convertible by this time. Other analysts have mentioned a more distant timeline of 15 to 20 years.
In April 2009, Zhou Xiaochuan, the governor of the PBoC, suggested that the IMF’s SDRs (Special Drawing Rights) should become an international reserve currency. At the time he indicated that the basket of currencies comprising the SDRs should be representative of major global economies in terms of GDP, suggesting the possibility of including the RMB in this basket of currencies. For this, again, the RMB would have to be convertible.