China’s rise from being the world’s sleeping giant to becoming a financial powerhouse, with an economy totalling 9.5% of global gross domestic product (GDP), has been stellar. Indeed, the country is destined to overtake the US in the next four years to become the largest economy in the world, according to the Organisation for Economic Co-operation and Development (OECD). As China grows corporate treasurers representing UK firms or other companies around the world need to know how to use the country’s currency, the renminbi (RMB) effectively for trade finance, offshore, in-country and learn about the governmental controls that still exist, even within the context of a continuing liberalisation programme.
Following years of protectionism, a shift in economic policy has seen China’s government embark on a carefully planned programme of reform over the past couple of decades, decentralising its trade institutions and gradually relinquishing its hold on free market movements. The programme, long incubated, really began in earnest with China’s entry into the World Trade Organisation (WTO) in September 2001 as globalisation was truly beginning to bite.
The Road to Convertibility and Internationalisation: A History
The liberalisation of the RMB has been central to this shift in China’s global economic position, with the currency on a seemingly inevitable path to full convertibility. RMB liberalisation has been carefully controlled, both to maintain government influence on the wider economy and, importantly, the stable progress of its now irreversible trajectory.
The stages of RMB development are stark to recount. It underwent policy liberalisation in 2002, after which East Asian regional development saw the introduction of ‘dim sum’ bonds in Hong Kong and currency swaps with South Korea between 2007 and 2009. These moves laid the groundwork as part of the Chinese government’s strategy for RMB to dominate its own region initially.
This has been followed, since 2010, by rapid internalisation. Measures have included the extension of trade and bond scope, and, importantly, the lifting of restrictions on foreign direct investment (FDI), and borrowing and lending. Further deregulation of China’s stock market last year – with the quota under which overseas institutions can invest increasing fourfold – signalled continued progress.
Total trade volume in RMB has grown from CNY18bn in Q12010 to approximately CNY245bn (GBP25.9bn) today, illustrating the rapid progress of internationalisation and how well the world has taken to the currency. That said, much of the rise is the result of increased trade flows between China and other Eastern Asian countries, and work remains in changing the culture of dollar-denominated payments between UK and western nations with their Chinese trading partners.
Eastern Promise: RMB as a Global Reserve
UK corporates operating globally now have a very real need to focus on their RMB strategies. By having capabilities to effectively trade in the currency – which is pegged to a managed floating exchange rate based on market supply and demand with reference to a basket of foreign currencies – companies can not only improve their competitiveness, but build stronger relationships with Chinese customers and suppliers.
Trade flows between the UK and China will greatly increase over the coming years as a result, but whether the UK can gain a proportionally greater share of business with China compared to its economic competitors remains to be seen. This in part depends on the way in which its corporates, financial institutions and trade bodies move to embrace RMB now, rather than being preoccupied by how it could develop to become a global reserve currency in later years. This timeline cannot accurately be predicted by anyone at the moment but ignoring its move towards becoming a global reserve currency is not an option either.
Trade relations between the UK and China have traditionally been strong, so the UK is already well positioned. With London also being one of the currency’s licensed offshore centres – albeit one with an urgent need to build up RMB liquidity and credibility – the City has a mandate to increase awareness of its overarching benefits.
For those that haven’t already done so, global companies with operations extending to the Far East need to recognise how to invoice trade, and organise account payables (A/P) and account receivables (A/R) in renminbi denominations.
Doing Business in Renminbi (RMB)
The practical implications for UK businesses and other western nations using RMB are obvious. While RMB is appreciating, the dollar is depreciating and this shows no long-term signs of abating. As such, Chinese corporates’ margins are being eroded by buying and selling in US dollars across borders when their costs are in RMB.
It is widely accepted that Chinese companies increase their prices to take into account the expected continued depreciation of the dollar. UK businesses pay for the privilege of using a convertible denomination. The country’s authorities also take longer to process payments in foreign currencies, with those in RMB taking just a day.
UK corporates can, therefore, extend benefits to their Chinese trading partners by being able to pay and accept payments in RMB. To offer flexibility and ensure that they too are realising the benefits, UK firms are increasingly looking to their banks to provide payment capabilities, currency accounts to hold RMB, and import and export trade finance solutions to meet myriad loan and documentation requirements.
The biggest drawback for UK and other western firms is currency risk. UK banks are providing foreign exchange (FX) facilities, which enable businesses to transact spot deals and bespoke currency risk management trades in RMB, as well as develop longer-term strategies to manage this. UK companies can set up an infrastructure that they will most likely need anyway, and are beginning to learn about RMB hedging in a controlled way with limited volumes.
The suite of RMB products available to UK companies is advancing and being increasingly adopted by global corporates via the international City of London trading and financing hub. However, there is a long way to go before UK-based international trading businesses use these tools en masse, with widespread education by financial institutions and trade bodies needed as trade volumes and interactions rise. The payoff for corporates comes in the form of discounts and preferential terms from their trading partners, stronger relationships and, ultimately, improved competitiveness in China. The value of this should not be underestimated, given the wealth of opportunity which exists in the region.
The Role of Banks
The common challenge for banks is supporting a totally foreign, regulated and controlled currency. Treasurers should only look to partner with banks that can handle this challenge. Processing A/R and A/P in RMB, for example, remains onerous given the specific procedures and supporting documentation required by the currency’s regulator. Furthermore, the policies of China’s central bank in respect of the currency are evolving quickly, keeping financial institutions and corporates in the UK and elsewhere on their toes.
While most banks are tackling these more practical hurdles effectively, the largest challenges remain in effective relationship support. After all, companies trading in RMB with Chinese partners have greater concerns than just banking processes and products. Predominantly, Lloyds Bank provides support to UK corporates from London, partnering with banks in China and other financial centres to effectively supplement firms’ RMB trading requirements overseas. This traditional banking arrangement gives reach and local expertise but each corporate treasurer must look to their own needs and requirements when deciding what model works best for them.
RMB Rising: The Next Phase
RMB still has some way to go before it sits alongside the US dollar and the euro (EUR) as a global reserve currency. China’s plans for its development are likely to remain carefully choreographed but, to be convertible and compete with the USD the country needs to establish entrenched financial markets, which is still some way off.
There is an imperative for large corporate treasuries to get their RMB strategies in order. By doing so, treasurers can achieve cost efficiencies and growth opportunities for their firms, as well as gain a march on their competitors in the region.
Corporates that embrace RMB and overcome the associated teething problems now, when volumes are lower, will gain experience in meeting the challenges of the future as further liberalisation occurs and will realise their Chinese trade ambitions faster.
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