Prior to the June 2009 pilot scheme by Chinese officials to establish the renminbi (RMB) as an international reserve currency, transactions between Chinese companies and their foreign counterparties were denominated almost solely in US dollars. As a result, the international trade markets had had very little exposure to the Chinese currency. But this is beginning to change as plans to internationalise the RMB progress.
The scheme has certainly come a long way since the roll out of the preliminary proposal, which allowed cross-border trade to be settled in RMB between a select number of Chinese enterprises and their overseas trade counterparts in just five mainland cities. The initiative has since been expanded to include all Chinese provinces and all countries across the globe, heralding a development that has the potential to revolutionise cross-border trade with China.
While corporates seeking to work with Chinese entities or expand into China have every reason to be positive about this development, it is not without its challenges. RMB trade settlement can improve supply chain visibility (by increasing pricing transparency), reduce foreign exchange (FX) costs and shorten settlement cycles, but the path to full internationalisation and convertibility is unlikely to run smooth.
Barriers to RMB Internationalisation
Although the primary intention of the internationalisation and convertibility of the RMB is for export settlement, data from the People’s Bank of China (PBOC) indicates that almost 90% of cross-border trade settled in RMB in Q111 involved China’s imports. This may be partly explained by the fact that the RMB remained undervalued, leading some companies to continue to hold RMB and/or delay payments to benefit from anticipated currency appreciation. While this is expected to gradually rectify itself as the advantages of RMB trade settlement become more widely understood and appreciated, the snags and setbacks that stem from China’s macroeconomic situation are not quite so readily resolved.
China’s economy is challenged by an asset bubble (real estate in particular) that is leading to price fluctuations, rising onshore inflation, and higher funding costs for domestic banks that come as a result of trying to keep inflation in check. As inflation drives up manufacturing costs, and therefore impacts competitiveness, it has been a key area of focus for the Chinese government, temporarily taking precedence over RMB internationalisation. Now that it is somewhat under control, however, the Chinese government is making a renewed effort to ramp-up the RMB initiative. This is despite the short-term economic hurdles and the possible impact of a potential policy change resulting from scheduled changes to the Chinese leadership.
Measures are now in place to enhance two-way investment and increase cross-border trade activity, and incentivise the use of RMB over US dollars for financing purposes. With such benefits in mind, trade entities – and their cash management providers – should make efforts to size-up the RMB market, particularly as regulatory complexity renders this a significant and labour-intensive challenge.
Striking a Difficult Balance
The intellectual and technical challenges associated with this burgeoning sector may mean that true expertise and capability will be the domain of specialist global providers of cross-border payments solutions. This is because smaller cash management providers are unlikely to be able to dedicate the time and resources required to keep abreast of developments and the resulting technology requirements, at least in the short term.
The timeline for RMB convertibility adds weight to this argument. While 2015 is the proposed target for full convertibility, the Chinese government is taking steps to develop the offshore market while simultaneously tightly controlling the onshore market. This is no mean feat and may mean that 2020-25 is a more realistic timeframe. Should this prove to be the case, many smaller cash management providers may find that they have more immediate concerns to address. As a result they, and their corporate clients, may fail to reap the full rewards that the internationalisation of the RMB can bring.
One way to resolve this issue would be for smaller providers to partner with global cross-border payments specialists. Although this would mean losing some control, doing so would allow them to capitalise on the opportunities RMB internationalisation presents without proprietary technology development costs, but with the knowledge and expertise needed to be a successful operator and innovator in this burgeoning area.
And of course, as the market opens up, the benefits for corporates of the RMB internationalisation will go beyond trade settlement cost and efficiency gains, eventually extending to investment opportunities and products designed to hedge risk and provide returns.
Although still in the nascent stages, one such opportunity is the development of the RMB as an asset class in the form of so-called ‘dim sum’ bonds. Named after the bite-size delicacy, these bonds are denominated in RMB and issued in Hong Kong and appeal to foreign investors who desire exposure to RMB-dominated assets, but are restricted from investing in domestic debt because of China’s rigorous capital controls. At such an early phase of development, any potential investors would need expert guidance and consultation before entering the emerging space.
The Future of the RMB
The internationalisation of the RMB is a bold move, and will bring benefits to all seeking to operate in China and trade with local entities. Benefits for suppliers include faster payment cycles and lower costs with regards to currency hedging, while buyers can benefit from a reduced administrative cost and burden when making RMB payments. Exporters also stand to gain, as transactions can be carried out more efficiently because fewer government organisations will need to be consulted prior to completion.
While internationalisation plans have suffered some difficulties and delays, there have been some key developments, such as the bilateral country arrangements that continue to be negotiated to ensure adequate RMB liquidity in international markets. Japan is the most recent example of this, with direct yen-RMB exchange now displacing the US dollar as the intermediary settlement currency. Looking from Asia to Europe, London is currently lobbying to be the next ‘official’ offshore location behind Hong Kong, with bankers’ associations prompting the Bank of England (BoE) to negotiate currency swap arrangements with the PBOC.
As promising as these developments are, it is important to keep sight of the potential challenges ahead. The RMB depreciated in value at the tail end of 2011 and potential changes in fiscal policy, as a result of a change in leadership or ongoing economic challenges in China, may alter the planned internationalisation path. However, given the positive impact the internationalisation of the RMB can have on trade with China, it is up to the banking community to work together to ensure that trade entities worldwide can fully benefit from the initiative regardless of any future hurdles.
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