Over the past decade, China has turned in impressive results. China’s trade with the world has grown six-fold from just under US$510bn in 2002 to almost US$3 trillion by the end of 2010, and now accounts for some 11% of world trade volume. Although China is now the world’s largest trading nation, most of the country’s trade continues to be denominated in US dollars.
Since the internationalisation of the Chinese national currency in 2010, the use of the renminbi (RMB) as a trade settlement currency has grown quickly. More than 10% of China’s foreign trade transactions are now denominated in RMB. According to SWIFT, the RMB has already grown to rank 17th among world payments currencies.
Drivers of RMB Payments Growth
Onshore and offshore corporations are driving the increase in demand for RMB-denominated trade. Importers and exporters can reduce costs, gain efficiencies, and improve customer and vendor relations through the increased use of the RMB as a trading currency.
Onshore corporations benefit by eliminating foreign exchange (FX) costs and from simplified financial reporting. They also reduce unnecessary paper work because State Administration for Foreign Exchange (SAFE) verification forms are not required for export customs declarations or for claiming export tax rebates. In addition, Chinese exporters have a natural currency hedge when both inputs and finished goods are priced in yuan, the unit of account for the RMB.
Offshore corporations can expect to improve negotiated prices with their trading partners because pricing in RMB is transparent and their counterparties don’t have to manage the FX risk and costs. Overseas corporations can diversify their currency portfolios and gain from the potential appreciation of the RMB.
These benefits mirror the policy objectives of the People’s Bank of China (PBOC). Invoicing trade in RMB eliminates risks for China because the national currency becomes the common unit of account, medium of exchange, and store of value. As volumes and convertibility improve, and the RMB effectively becomes a reserve currency, the need for China to accumulate large external reserves will decline.
Implications of RMB Growth
It is unclear whether the shift to using RMB will lead to more trade and investment, rather than simply a redenomination of existing activities, but there will be a shift in risks and costs.
The principal change will be a shift in FX risk from Chinese to overseas corporations. This will be particularly true in the manufactured goods sectors, but less so for commodity producers as most commodities will continue to be priced in US dollars for the foreseeable future. We can see this in the recent data in the March issue of the ‘SWIFT RMB Tracker’. RMB payments among China’s largest Asian trading partners are up sharply, except for its biggest regional trading partner and major commodity supplier, Australia, which now lags the field at a mere 2% of payments across currencies.
Even if a large portion of trade is not redenominated into yuan, with the development of the FX markets and swap agreements, it is likely that more bilateral trade in national currencies will occur without the intermediate translation into the US dollar. Trade in national currencies and greater use of the RMB is already occurring across many local Asian markets and between Russia and China today. Overall, FX volumes are likely to fall with the broader use of the yuan, and this will have the greatest impact on the US dollar service providers.
The bulk of RMB payments volume, close to 80%, is with Hong Kong, and this has been the centre of most of the innovation in RMB products and services. With the expanded use for trade, the need for yuan-based loan, deposit and investment products will continue to develop along with the associated payment flows. At the end of January 2012, there were almost 3 million demand, savings and time deposit accounts, with balances totalling RMB576bn (US$91bn), held at 134 authorised financial institutions in Hong Kong. Clearly, more RMB cash management, risk management and hedging products will have to be developed to meet the evolving needs of the market.
Analysts have been watching the increase in use of the currency. Given the strength of current trade flows, many analysts are predicting that the RMB will become a world reserve currency within the decade. Interestingly, the central banks of Nigeria, Chile, Thailand, Brazil, Venezuela and most recently Japan have already begun efforts to include RMB in their reserves portfolios, even if only at modest weights.
Whether the RMB finally becomes a world reserve currency in this decade or the next, the trend is clear.
Get Ready to Meet Demand
Given continuing restrictions on capital account (cross-border investment) transactions, the bulk of RMB payments activity is driven by trade. Although, more than 1,085 financial institutions, from 95 countries doing business with China, have completed transactions in ‘the people’s currency’, according to a recent report by FImetrix, ‘Trade Payments with China: A Perspective on the Growth of the Renminbi as a Trade Settlement Currency’, bankers around the world may not yet be ready to meet the emerging demand for RMB services.
Over the past two years, the team at FImetrix asked over 600 financial institutions worldwide, and more than 900 corporations in North America, about their current and future use of the RMB as a trade settlement currency.
Of the banks surveyed only 37% had executed, or had an interest in executing, RMB payments covering trade with China. Not surprisingly, the main driver for the banks’ interest is in response to customer demand (74%) and the related objective to offer services to meet corporate client needs (64%).
Where interest was weaker the main reason was that a large volume of trade with China is in commodities that are still typically priced in US dollars.
The modest level of interest reported in the studies is perhaps not as surprising as it first appears. The Asia-Pacific study was conducted in early 2010, and accounts for most of the ‘not sure’ responses. The Latin America study was completed in the fall of 2010 and accounts for a large portion of the ‘not interested’ responses. These were early days for the RMB as a trade currency. In addition, through 2010 and 2011, transaction bankers had conflicting priorities as they dealt with the euro debt crisis and evolving regulatory and compliance requirements.
Actual payment volumes reported by SWIFT show that onshore and offshore corporations are recognising the benefits of RMB denominated trade.
With regional trade accounting for roughly half of China’s merchandise trade volume, the results from FImetrix’s latest study with banks in Asia and the Pacific Rim, available later in 2012, should provide additional insights on the development of the RMB market and banking capabilities in the region.
China is also the world’s second largest buyer of oil, and there have been pressures to settle more of the oil trade with the Middle East and Russia in yuan. News that China is looking to expand offshore yuan trade settlement to the Dubai International Financial Centre (DIFC), in the United Arab Emirates (UAE), should support a move to more commodity trade in yuan. Not only would increased yuan-denominated commodity trade significantly enhance its status as a global currency, it would encourage additional bilateral trade and growth by boosting the available pool of offshore yuan.
RMB Services Still in Their Infancy
Respondents to the FImetrix studies showed their relative inexperience with the new currency. When asked about preferred locations to settle RMB transactions more than two-thirds of respondents were either unable, or chose not, to answer. Of those that did respond, Hong Kong and Shanghai shared the top mentions.
Similarly when asked what other services they would expect from their RMB settlement bank fewer than 30% responded, mentioning “funding in RMB” two to one over “risk mitigation through risk participation”.
To date there is no clear data on how effective banks have been in incorporating their RMB provider’s capabilities into their trade and banking services, and communicating their own RMB value proposition to their corporate clients. The rapid volume growth reported by SWIFT, and high levels of corporate demand reported by interested banks in FImetrix studies, suggest that corporate practitioners, on and offshore, are ahead of many of their bankers with their RMB strategy.
The rise of the RMB is not without its challenges. The currency is still not freely convertible in the capital account so there are still restrictions on moving funds onshore, cross-border yuan settlement is relatively inefficient, and RMB loans and risk management products still lack the availability and liquidity of their western counterparts. However, PBOC has local currency swap agreements with more than a dozen countries, there is an active interbank FX market in London, nine major currencies now trade in the domestic interbank FX market, and there are continuing developments and innovation in RMB deposit, loan and risk management products.
As a result, bankers around the world must have a sound strategy for this emerging currency, and begin implementing the policies, procedures and infrastructure to serve their larger corporate clients, because the RMB isn’t going to wait.
Given the current capability and calling activities of the leading Chinese and global banks, failure to act will leave many banks well behind their competitors, and likely to lose a significant share of their trade payment and FX volumes.
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