China has made extraordinary strides towards internationalising the renminbi, and it is now time for the global community to recognise that the economic architecture needs to evolve to keep pace with the changes.
While the world has been focusing on Europe’s woes and America’s new stimulus programme, the renminbi quietly passed another key milestone on its path towards becoming a global currency.
The process of internationalisation is accelerating, driven principally by growth in trade settlement
Last July the yield spread between 5-year onshore Chinese government bonds and those traded on overseas exchanges narrowed to just 9 basis points. A year earlier the spread stood at almost 300 points.
The higher price paid by onshore borrowers last year reflected the frictional costs created by Chinese controls. The convergence of the bond yield is an unequivocal vote of confidence in Beijing’s programme of currency normalisation.
The disappearance of the yield spread, when considered alongside the broadly shared agreement that the RMB has reached market equilibrium with the US dollar, are clear indications that the walls that have sequestered the Chinese currency from the global economy are crumbling fast.
The Chinese government has made substantial progress on all the three key steps to full convertibility of the renminbi: deepening and liberalising the local capital markets; relaxing restrictions on the exchange rate; and allowing the markets greater say in setting interest rates.
The Qualified Foreign Institutional Investor programme, which gives foreigners direct access to China’s capital markets, has been expanded by USD7.3 billion so far this year to USD29.8 billion; the onshore interbank market is being liberalised; interest rates have been allowed to float 10 per cent above and 30 per cent below the rate set by the People’s Bank of China; and the daily amount which the renminbi can fluctuate has been doubled to 2 per cent.
September’s creation of a deliverable renminbi futures exchange in Hong Kong also marks a key step in establishing a functioning feedback loop for market-set exchange rates, as do the memoranda of understanding signed with Singapore and Taiwan to establish RMB clearing centres.
We need to recognise that a global reserve regime that stands on three legs is going to be more stable
The process of internationalisation is accelerating, driven principally by growth in trade settlement. China first permitted trade RMB settlement in 2009, and since then it has grown to account for more than 10 per cent of China’s total trade, and continues to expand.
The recent plateauing of the renminbi deposit growth in Hong Kong at around RMB550 billion has been mistakenly interpreted by some analysts as an indication of slowing market interest in the currency itself and the internationalisation project more broadly.
But the slowdown in deposits is a mark of success rather than weakness. Some speculative investment has been driven out of the market since the renminbi reached equilibrium with the dollar, and other funds have migrated over the border into the onshore market.
The market for Dim Sum bonds is also slowing but at RMB224 billion, issuance this year is more than 18 per cent up on last year, despite the growing attractions of the onshore market.
We believe that benchmark CNH (offshore renminbi) yields will eventually move higher than their onshore equivalents as investors gravitate towards the greater return, depth and variety of mainland Chinese debt.
But we have to remember that full convertibility of the renminbi is still some way off.
The Chinese domestic bond markets are currently worth RMB22 trillion – a fraction of the USD37 trillion American or EUR14.8 trillion European markets – and dismantling the remaining capital controls will be a delicate process not without risk for the Chinese government and the economy more generally.
The government in Beijing is pressing ahead with reform with what is impressive speed in historical terms. It is worth remembering that some European nations took 20 years to achieve full convertibility.
Given the importance of China to the broader global economy, there is a growing hunger for an alternative to the US dollar.
Recent research by Arvind Subramanian and Martin Kessler of the Peterson Institute for International Economics indicates that the renminbi has already superseded the dollar as the most important reference currency for most East Asian economies.
It is a trend that is likely to accelerate. The People’s Bank of China has signed currency swap deals with Australia, Japan, Mongolia and South Korea among others. Some countries, including Chile and Nigeria, are already dipping their toes into the renminbi-as-reserve waters.
Now is the time for the outside world to consider what steps it needs to take to assist and reward the Chinese government for their bold moves towards internationalisation.
We need to recognise that a global reserve regime that stands on three legs is going to be more stable, particularly given the current uncertainties in Europe and the USA, and take active and meaningful steps to support China’s efforts.
The global community, as controllers of the IMF, should fast-track the inclusion of the RMB into the basket of currencies used to determine the value of special drawing rights (SDR), a move that will reciprocally reinforce the reforms now under way in Beijing.
The recent loosening of restrictions on the renminbi means that it now broadly satisfies the conditions laid down by the IMF in November last year, when it said the next SDR meeting was not due until 2015, “or earlier if the Fund finds changed circumstances warrant an earlier review, to ensure that it reflects the relative importance of currencies in the world’s trading and financial systems”.
The signals being sent by the bond and foreign exchange markets are clear: the renminbi is getting ready for formal international recognition.
This article was first published in the South China Morning Post on 29 October 2012.