Before China’s renminbi (RMB) can challenge the dollar, it first needs to be freely available for trade and investment. By internationalising renminbi through offshore financial markets, China is introducing openness and transparency while retaining greater controls over its home market and capital account.
This process has started in some Asian countries and is spreading quickly to other parts of the world.
Bilateral trade between China and the Southeast Asian economic bloc reached a record high of USD400.9 billion in 2012, a year-on-year increase of 10.2 per cent. China is increasingly “near-sourcing” raw materials, components and finished products from within Asia. Trade between these two huge markets will continue to grow and if a sizable proportion of an emerging-market country’s trade is with China, it can make sense to settle that trade in renminbi.
Bilateral trade between China and the Southeast Asian economic bloc reached a record high of USD400.9 billion in 2012
This is already happening in Hong Kong. Cross-border trade settled in yuan increased 6.6 per cent in August to RMB304.2 billion on a month-on-month basis, according to the Hong Kong Monetary Authority. This has helped Hong Kong generate the largest renminbi liquidity pool outside mainland China. Taiwan and Singapore are catching up quickly after setting up clearing services earlier this year.
HSBC Global Research forecasts that by 2015, one third of China’s total trade and half of the trade between China and emerging markets will be settled in renminbi.
Growing offshore use of renminbi is not confined to Asia: Europe is now the largest contributor to renminbi payment growth. According to Swift, London accounts for 28 per cent of offshore transactions settled in renminbi with China and Hong Kong, and RMB settlement has more than doubled in France, Germany and Luxembourg in the past year.
For a currency to achieve investment, and ultimately reserve status, it has to create incentives for foreigners to trade and hold it. It is worth pointing out that trading of the Chinese yuan in global foreign exchange markets has more than tripled from three years ago because of the expansion of the offshore market. Daily turnover in renminbi has increased to USD120 billion from USD34 billion three years ago.
Dim sum bonds opened the door for foreign companies to finance in the Chinese currency.
Chinese regulators have increased the quota for Renminbi Qualified Foreign Institutional Investor (RQFII), which stands at 270 billion yuan (USD44 billion) and around half that had been taken up by last month. The authorities almost doubled the quota of the Qualified Foreign Institutional Investor (QFII) scheme to USD150 billion as Beijing moves to widen channels for foreign investors to buy mainland stocks, bonds and money-market instruments.
According to the International Monetary Fund, rapid liberalisation of cross-border capital movements could produce over several years net outflows from China equal to 15 per cent of the country's gross domestic product, amounting to some USD1.35 trillion. The holders of China’s vast domestic savings pool may also seek diversification in overseas markets. This would increase global renminbi liquidity, providing another boost to the currency’s internationalisation.
As China’s importance as a trading power increases, some central banks are, or planning to, include renminbi in their reserve portfolios. Taiwan’s central bank has added renminbi assets to its foreign reserves portfolio and the Reserve Bank of Australia intends to hold up to 5 per cent of its reserves in renminbi assets. At the same time, the People’s Bank of China and the European Central Bank have a three-year bilateral currency swap agreement worth 350billion yuan (USD57 billion) to provide further liquidity support for renminbi use overseas. An additional 23 central banks and monetary authorities have signed similar arrangements.
China is now further internationalising its currency by encouraging the development of multiple offshore centres, not only Hong Kong, Taiwan, Singapore and London. Others such as Toronto, Luxembourg, Zurich, Paris, Frankfurt and even Sydney are quickly catching up and will help the renminbi grow.
International currencies should have three basic characteristics: convertibility; broad acceptance and wide use in various areas of international trade, settlement, investment, debt payment; and stable value. Current account convertibility has now been achieved and restrictions on the capital account are being loosened. Renminbi is rapidly becoming not just acceptable but desirable in the mercantile capitals of the global economy and is showing every sign of being a currency of the future.