Much has been written about the internationalisation of the Chinese renminbi (RMB) since China took the first bold step to allow the settlement of cross-border trade in RMB (otherwise referred to as the CNY) in 2009. What started out initially as a pilot scheme for importers and exporters in five Chinese cities (Guangzhou, Shenzhen, Zhuhai, Dongguan and Shanghai) to settle their trade in RMB with enterprises from Hong Kong, Macau and the ASEAN countries has taken off so rapidly that today you are unlikely to hear any doubt on the future pace of the liberalisation.
The market may slow down intermittently since the players are also driven by opportunities to arbitrage the RMB against other foreign currencies and the Chinese authorities need to fine-tune the regulatory framework as the market develops. However, the pace of the liberalisation towards an international currency is clear: it can only go forward.
The milestones in Figure 1 set out the progress achieved to date:
Cross-border Trade Settlement Volume
The bar chart in Figure 2 shows the cross-border trade settlement volume in RMB since the launch of the scheme. The volume speaks for itself on the keen interest in the RMB trade settlement, despite a brief pause in Q311 and Q411.
The aggregate trade settlement volume (Figure 3) of RMB2.08 trillion in 2011 represents an estimated 9.1% share of China’s global trade volume. Based on People’s Bank of China (PBOC) data, an estimated 58% of the RMB trade settlement volume was between Hong Kong and mainland enterprises in 2010. This is hardly surprising as many business enterprises from Hong Kong have manufacturing operations across the border and likewise Chinese enterprises have established trading or sourcing arms in Hong Kong to leverage on each other’s strengths.
It is worth noting that Singapore has also been catching up on RMB cross-border trade settlement with about 21% share in 2010 as Singapore banks actively seek to intermediate the cross-border trade by rolling out a slew of RMB-related services such as CNH (offshore RMB deliverable in Hong Kong) fixed deposits, CNY remittance services, RMB financing and foreign exchange (FX) hedging solutions. The anticipation that China is likely to set up another offshore clearing centre (similar to Hong Kong’s CNH offshore clearing) has also boosted local sentiments.
ASEAN: An Important Catalyst for China’s RMB Internationalisation?
What is perhaps surprising is that ASEAN trading partners have not really plugged into the cross-border RMB trade settlement (other than Singapore, which is a distant second from Hong Kong). The formal launch of the ASEAN-China Free Trade Agreement (ACFTA) in January 2010 paves the way for trade flow among the regional grouping to fast forward as 90% of the products traded will enjoy zero tariffs, according to Dr Surin Pitsuwan, ASEAN Secretary General1. ACFTA will create an economic region with 1.9 billion consumers and combined GDP of US$6 trillion dollars. The importance of China as a trade partner can hardly be overemphasized, considering that China is the third largest trading partner of ASEAN.
The integration of the ASEAN-China economies is also expected to generate a surge in investments to and from China. Some key sectors that have already attracted Chinese companies include energy, mining and infrastructure projects. Conversely, China remains an attractive destination to ASEAN for foreign direct investment (FDI) due to the sheer size of its market and the synergies of its supply chain. Such investments will add a further dimension to the RMB internationalisation process. As it is, Singapore is one of the countries with sizeable investments in China.
With the economic growth in ASEAN set to gather further momentum led by rising consumption spending, ASEAN-China bilateral trade will continue to command a greater share of China’s global trade. Hence, the importance of ASEAN in the RMB internationalisation process should not be under-estimated.
Why Are ASEAN Enterprises Not Integrated into the RMB Internationalisation Yet?
Before importers and exporters jump onto the bandwagon, they must be fully convinced that trade settlement in RMB is to their advantage. It is easier to convince Chinese enterprises since settlement in RMB means that the FX risk has now shifted to its overseas clients. In fact, onshore Chinese enterprises may be able to enjoy additional cost savings by optimising their liquidity management. Trading enterprises are also able to leverage on the well-developed market and infrastructure to conduct RMB remittances and to maximise the returns by deploying excess RMB funds.
For the ASEAN enterprises, it is another paradigm shift as the settlement of another currency may raise other implications from the business perspective, such as the availability of financing, FX risks, liquidity management issues and other added costs.
Trade Financing Solutions
Even before the RMB scheme was launched, the US dollar has been the preferred currency for international trade settlement. Securing trade financing against an export letter of credit (L/C) or under documentary collection (document against acceptance) is relatively easy for the exporter as it can leverage on the undertaking of the L/C issuing bank or the receivables to provide credit enhancement. If the borrower is buying and selling in the same currency, there is no FX exposure, unlike RMB where often the overseas exporter may be selling in RMB but buying in another currency. This is the prevailing situation, even for enterprises in Hong Kong, as the RMB scheme mainly appeals to overseas exporters (partly also because of the expected appreciation of the currency as China opens up further).
The settlement of the cross-border trade in RMB would require banks to create the right value propositions for their customers. Financial institutions in Singapore, including DBS Bank, have been more proactive in creating innovative financing solutions to meet such cross-border trade. A typical financing solution allows the exporter to obtain financing in US dollar by discounting the RMB L/C upon shipment. As the receivables are in RMB, the bank would require the borrower to enter into a non-deliverable forward (NDF) to hedge the FX risk (this financing structure is illustrated in Figure 4). For Asian enterprises to embrace the RMB currency for trade settlement, it is inevitable that banks in these markets need to offer such innovative financing solution to their clients.
FX Hedging Solutions
The denomination of the cross-border trade in RMB creates a FX risk for the overseas trading partner. While it is possible that some exporters may be prepared to arbitrage on the appreciation of RMB, it cannot be true for most enterprises as an unfavourable exchange rate may erode the profit margin entirely or even cause a loss to the exporter.
Banks in Singapore and Hong Kong are well ahead in developing FX hedging products such as NDF, offshore delivery forward in CNH and interest rate swaps in both these well-established financial centres. Such hedging instruments would need to be available to support the development of RMB trade settlement in ASEAN markets.
It goes without saying that for RMB trade settlement to gain acceptance, the financing and trade settlement cost need to be comparable with the alternative US dollar settlement, if not lower. The lack of offshore RMB liquidity may impede the growth of trade settlement in these markets as banks outside China will need to fund the financing at a higher cost, which will be passed on to the importer or exporter overseas. Although PBOC has established bilateral currency swap agreements with some of the ASEAN central banks, in the long run the solution can only be solved by developing an active retail or wholesale deposit market in RMB.
In addition to financing cost, it is imperative that the trade settlement in RMB must be supported by infrastructure to facilitate the cross-border funds clearing either directly with designated clearing banks in China or through Hong Kong. The cost for such trade settlement should be competitive vis-à-vis US dollar settlement through New York.
From the cash management perspective, it is essential that any excess RMB funds be deployed efficiently. This requires that cash flow generated from receivables in RMB can be invested either in short-term assets or medium-term instruments to provide an acceptable return. Short-term assets can include time deposits or structured deposits. Such products should be made available to both retail and wholesale clients to attract liquidity in RMB.
As the liberalisation of the currency gathers pace it is necessary to create sufficient depth in FX trading and develop the capital and debt markets further. While Hong Kong has been actively developing its market due to its cross-border trade and the strong support from the Chinese authorities, there is a need to inject further liquidity within ASEAN markets to entice the holding of RMB funds or assets among the retail and wholesale segment. This is particularly true as the trade and investment flows between the ASEAN bloc and China is set to grow even further with ACFTA. Also, as Singapore is already an established financial centre, there are obvious synergies that it can provide to banks and non-bank institutions in ASEAN. In this connection, it is not far-fetched for Singapore to be positioned as the next RMB offshore clearing centre.
Changing Regulatory Landscape
The changing regulatory landscape creates another major challenge for banks that are engaged in RMB trade settlement and financing. The dynamic changes in transparency, capital adequacy and reporting regulations have imposed additional resource constraints on the back office because new controls and processes have to be put in place to ensure compliance.
This post-crash regulatory landscape and China’s own changes are a challenge for banks that do not have a robust system to respond to such changes in a timely manner, and could ultimately adversely impact corporations’ financing. In fact the changing situation could create an entry barrier for institutions in some ASEAN countries that are not well equipped to handle the necessary technology investment.
The journey towards RMB liberalisation has hardly begun and already so much progress has been made. Certainly, there will be fine-tuning along the way as the signal from China seems to point towards a measured pace towards internationalisation of the RMB. The direction is clear but it will take a few more years before China achieves the coveted status of having RMB as an international currency along with perhaps equal standing as the US dollar. Until that stage is reached, ASEAN, together with the rest of the other trading nations involved with China, will play an important role in the internationalisation process.
The progress towards liberalisation has reached a point where most would agree that it is not a question of ‘if’ but rather ‘when’ the RMB becomes fully convertible and accepted as an alternative reserve currency by the international community.
1Xinhua, 25 October 2009.
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