As China´s financial markets have opened up to foreign investors, the Chinese government has decided to launch and market the Chinese renminbi (RMB) as an international trading and reserve currency. This creates many benefits for companies that trade with China, as it gives them an opportunity to hedge their currency exposure more effectively, to strengthen their negotiation position and to extend their presence in China. It has caused the use of the RMB in cross-border payments to increase fourfold in just a couple of years, to 18% in 2013, and its use is expected to further increase significantly over the coming years.
The process is, however, a balancing act for the Chinese government. Traditionally, it has based its policy on capital restrictions, as these offer protection against economic storms and allow the authorities to manage the exchange rate and interest rates without losing control over inflation. The same restrictions, however, have deprived Chinese companies and households of the benefits of economic competition. Now that the government wants to liberalise its currency market, it is thus a question of opening the financial taps at just the right pace to avoid flooding at any of the stages.
Interest in trading in the RMB is increasing steadily. At present, daily turnover in the CNH – the currency code for the renminbi when traded outside China – is approximately US$5-6 billion, or double the level of just one year ago. The number includes both spot and forwards. The use of the RMB in cross-border trade transactions is expected only to increase.
Triennial Central Bank Survey
from the Bank for International Settlements (BIS) shows that more than 53% of all cross-border flows between Hong Kong and China are now being conducted in RMB. France is the highest-ranked country in the eurozone in terms of turnover and is in third place overall (excluding China and Hong Kong) with 21.4% of all cross-border flows transacted in RMB, up from 6.5% a year earlier. The Nordic countries are lagging behind their competitors when it comes to adopting the RMB as invoicing currency.
Benefits on Both Sides
The fact that the RMB is attractive is no surprise, as a switch to the currency quickly produces benefits for foreign companies. Alongside more effective currency hedging, a switch to the RMB also provides an opportunity for more attractive negotiating positions for foreign companies.
A survey conducted by Deutsche Bank, among its clients in 2012, shows that companies that switch over to RMB can earn an average of 4-8% in price negotiations with Chinese counterparts. This discount is assumed to represent what Chinese companies are willing to give up to get rid of the currency risk. Another example of the interest in the RMB is the increase in the trading of options in both yuan (CNY) and CNH. Data from the above mentioned BIS survey shows that in terms of turnover on the global options market, RMB has climbed to sixth place, including both onshore and offshore flows.
A switch to the RMB also gives foreign companies an opportunity to move deeper into the Chinese market, as many Chinese companies are not able to hedge exposures in foreign currency due to local regulations. But even among companies that have the opportunity, there is a value in avoiding the currency risk. Currency trading in China is still in its infancy and is strictly regulated by the central bank. The level of sophistication in trading has not yet caught up with the more established, unregulated currencies.
As an example, Swedish companies with manufacturing in China, which used to pay their Chinese suppliers in US dollars (USD), will halve their currency risk by switching to the RMB. Where there used to be a USD/CNY risk for the Chinese company and a USD/Krona (SEK) risk for the Swedish company, there is only a CNH/SEK risk left for the Swedish company. The Chinese currency is today only allowed very limited movement. Therefore the exchange rate between CNH and foreign currencies is more a function of how the US dollar moves against these currencies than of moves in the Chinese currency itself. If the company currently has an effective hedging policy, there is therefore no reason to abandon this when switching to the CNH.
For Chinese companies, switching to the RMB brings a benefit in the form of a simplified documentation process, as there is no need for a currency exchange, which in many cases also can be expensive. The company has quicker access to its funds, as there is no exchange and the risk of delay is reduced.
As with all policy decisions in China, the decision to launch the RMB as an international trading currency is not something that happens overnight. The internationalisation process was launched about 10 years ago. The government is now implementing a number of measures to prepare the market for the day when the currency becomes freely convertible. Although the Chinese RMB is still a distant competitor to the US dollar, its entry into the international markets thus gives rise to issues for both Chinese authorities and multinational western companies.
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