China leapfrogged Japan to become the world’s second largest economy in 2011 and this tremendous growth has driven the liberalisation of the Chinese market and its currency, the renminbi (RMB). In turn, the progress made towards RMB liberalisation has allowed China to open its doors to even more international trade and China’s economy is continuing to grow, albeit at a reduced rate compared to the past few years.
The country now has new political leaders, but it is expected that the liberalisation of the renminbi will continue gradually – in accordance to the current five-year plan which spans from 2011 to 2015. What is changing is that domestic consumption has increased in China and there are indications that the government wants to increase the quality of its manufacturing sector, rather than continuing to produce cheap goods for export. So how are these factors – currency policy and China’s growing economy – affecting corporates in Europe?
The Path to Liberalisation
In July 2009, the Chinese central bank, the People’s Bank of China (PBoC), introduced the renminbi cross-border trade settlement scheme, the aim of which was to enable selected Chinese enterprises to trade in RMB cross-border with Hong Kong, Macau and countries in the Association of Southeast Asian Nations (ASEAN). This pilot scheme was soon expanded to enterprises in 20 Chinese provinces handling trade business in RMB worldwide. Already in 2011 the programme had been extended to all Chinese provinces. In addition, for a target group of corporate customers with regular business transactions the PBoC introduced in the second half of 2012 two new pilot programmes for facilitating the handling of renminbi cross-border payments and lending RMB to offshore subsidiaries, increasing the payment flow and indicating further steps towards the liberalisation of the renminbi.
In the first six months of 2011, cross-border trade settlement in RMB had increased by more than 13 times the volume for the first half of 2010 – to 957.57bn (US$152.424bn), according to PBoC’s statistics.
From October 2011, it became possible to make an RMB capital injection into a foreign invested enterprise (FIE), including wholly-owned foreign enterprises (WOFEs) and joint ventures (JVs) in China. These were great steps forward, which facilitated the internationalisation of the currency and also induced companies to open RMB accounts outside China. Some of the benefits of having an RMB account outside China and trading in RMB include:
- Invoicing of import and export business in RMB.
- Fixed prices in RMB with reduced subsequent price adjustment and negotiations.
- Undertaking the currency risk by invoicing in RMB for a stronger negotiating position and consequently a better pricing.
- Integration of RMB in central currency hedging and controlling.
- Strengthening and expanding market position and business opportunities with and in China.
RMB is increasingly used in trade finance contracts and the international capital markets are showing more activity in the offshore market, whether that is in Hong Kong, Singapore, Taiwan, London, Frankfurt or New York. Of course western banks are reacting to this and are offering RMB products and business solutions, including foreign exchange (FX) trading and investment opportunities. As a bank with a strong trade finance business, Commerzbank of course offers its trade products and services in the Chinese currency. The bank also accompanies corporates that want to expand or establish new business in China by providing advisory services and on site assistance at our own branches in Shanghai, Beijing, Tianjin and Hong Kong, as well as via a network of partner banks in China.
China is Germany’s main trading partner outside Europe – according to World Trade Organisation (WTO) statistics for September 2012, 8.9% of Germany’s imports come from China (the second largest trading partner for imports after the EU, which supplies 54.8% of imports). This means that the importance of the RMB as a trade finance currency has increased and is likely to grow.
China’s large banks are also reacting to developments. They are increasingly competing for offshore and onshore business and are establishing their markets in the west. ICBC, for example, has doubled its presence in Europe in recent years. In particular it is winning offshore business from the growing number of Chinese companies investing in Europe.
An Increasing Role on the International Stage
The liberalisation of China’s currency is progressing, but how likely – or how soon – is it going to become a real challenge to the US dollar as a global reserve currency? This is difficult to predict, but last year the PBoC announced the free convertibility of the RMB by 2015. This process may well take longer and will depend on market developments and China’s economy. One thing is certain, however, and that is that the Chinese government wants to promote its currency as an international reserve.
Two important trends that are strengthening its hand in this respect are:
- The increased use of RMB in trade contracts: dollar and euro will no longer be the only currencies for trade contracts. The renminbi is now gaining a share of this market supported by currency swap agreements. China has already signed bilateral currency swap agreements with more than 15 countries worldwide, like Russia, Hong Kong, Japan, Turkey, UAE, Australia, and Brazil. At the end of October South Korea doubled its currency swap deal with China. As a consequence of these currency deals, more bilateral trades with China are paid in RMB and the respective local currency. Transactions costs are reduced and dependencies to the US dollar reduced.
- Increasing flexibility: While the RMB is still not freely convertible, there is more flexibility than there was. Under the pilot cross-border trade settlement scheme, more services can be paid for in RMB and inter-company payments are also permitted with the approval of the State Administration of Foreign Exchange (SAFE).
The currency’s role in international trade will also depend partially on other factors, such as:
- Companies’ ability to process their international cross-border trade business in RMB without proving a direct trade relationship to mainland China. Currently, this is still an important requirement.
- Payment flows (for exports and imports) in RMB need to increase so that corporates can hedge the balance of incoming and outgoing payments rather than each separate position. The spectre of trapped cash and how to get it out of China is a continual issue for treasurers’ at large multinationals in China.
Chinese Business Among German Mittelstand
How have Germany’s small and medium-sized enterprises (SMEs) reacted to the increasing liberalisation of the renminbi? While SMEs have shown interest, they were initially hesitant about opening RMB accounts and processing cross-border trade payments in the currency. However, in common with other banks, Commerzbank has seen a significant increase in the amount of RMB accounts and the volume of cross-border payments in renminbi.
Decisions to adopt RMB are often driven by Chinese trading partners or by western corporates that wish to integrate RMB into their FX management programme, in order to control the hedging and flow of currency centrally.
Overall, a growing demand for letters of credit (L/Cs) and capital transfers outside the RMB trade settlement is discernible. This is due to European companies investing in China but also the needs of Chinese companies based abroad. RMB cross-border cash flows, RMB accounts outside China and the use of the currency in trade contracts will increase – and this growth will continue in line with trust in China’s economy and its new leadership, as well as a greater awareness of the advantages of trading in the rising currency.
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