Alongside China’s growing economic clout, its currency is also gaining increasing international recognition. With the direction of the US dollar uncertain and the euro weighed down by mounting debt concerns, the global business and banking communities are increasingly regarding China’s currency, the renminbi (RMB) or yuan as it is also known, as a future global reserve currency.
Over the past 18 months, an entire offshore RMB financing industry has sprung up, centred in Hong Kong, as banks and corporates scramble to take advantage of growing demand for and interest in RMB-denominated assets. According to research by Standard Chartered, the total pool of yuan-denominated deposits could hit $1 trillion by 2015. The offshore RMB market in Hong Kong alone is set to triple in size this year to RMB1.2 trillion.
“With the general market consensus that the RMB is on an appreciating trend, there is strong demand to hold RMB offshore,” says Neil Daswani, regional head of transaction banking, north Asia, at Standard Chartered. Daswani notes early signs of it being considered a “reserve currency” by the Hong Kong Monetary Authority (HKMA), which has announced plans to integrate the yuan into its currency portfolio.
But despite its rising prominence, the offshore renminbi market remains small in actual terms, while currency restrictions imposed by Beijing mean that relatively few people outside the mainland have ever held a Chinese banknote, let alone attempted to spend one; very few non-Chinese corporates have ever settled a transaction using the RMB, let alone used it to underpin the raising of debt or equity capital. There is clearly, therefore, a long way to go before the renminbi becomes a global reserve currency, not least the thorny issue of full convertibility.
DIM SUM BONDS
China’s currency is slowly gaining prestige and prominence across the globe, with Hong Kong emerging as the centre of the new offshore RMB industry.
According to the HKMA, cross-border RMB trade settlements handled in Hong Kong reached RMB370 billion ($57 billion) in 2010, with yuan deposits held in Hong Kong more than tripling last year, to RMB315 billion.
Global corporates, meanwhile, are testing the water with so-called “dim sum bonds” issued offshore in Hong Kong but denominated in yuan. Institutions as diverse as Agricultural Bank of China, McDonald’s, Unilever and the financing arm of construction equipment maker Caterpillar have issued such bonds over the past 12 months. By end-January 2011, corporates and institutions had raised RMB74.4 billion from 31 dim sum issuances.
Other yuan-denominated financing options are continuing to emerge. Real estate investment trust Hui Xian Real Estate Investment Trust raised RMB10.5 billion in its initial public offering (IPO) in Hong Kong on April 20, in Hong Kong’s first ever yuan-denominated IPO.
TUCKING IN
For multinationals, the rationale behind issuing yuan-denominated debt appears clear.
First, the currency will grow in depth and ubiquity, so understanding it early is reasonably important. Second, the process is quick and straightforward. Issuing a typical dim sum bond takes around four weeks from launch to capital, and pays a coupon of between 1% and 5.25%. Finally, issuing debt offshore but in RMB is a way of courting the Chinese authorities without breaking the bank.
The size of dim sum bonds issued by multinationals to date has been relatively small – McDonald’s yuan-denominated debt issue in Hong Kong in August 2010 totalled RMB200 million ($30.7 million), not an insignificant amount, but small in relation to the corporation’s record $24.1 billion in revenues in 2010. The move garnered approving media coverage on the mainland and in the region as a whole and served to reinforce the RMB’s growing offshore credentials.
“Some dim sum bonds by multinationals are in very small amounts, but they are seen as a way of showing China and their own customers that they are an early adopter of an important new financial market,” says Gilles Plante, north-east Asia CEO at ANZ Bank.
The identity of the multinationals that have issued dim sum bonds to date is also telling. All have big China presences in terms of sales and product sourcing and, according to industry observers, mainland suppliers are increasingly asking multinationals sourcing from China to consider invoicing and settling in RMB.
CURRENCY AMBITIONS
Corporates realize that it is now Chinese government policy to boost the yuan’s role in trade settlement. China has always viewed an internationally tradable currency as central to its economic future, but until the global financial crisis that dream seemed years, even decades, down the line.
Post-crisis, the government senses its opportunity, hence the timing of recent developments: Beijing launched a pilot cross-border renminbi settlement scheme in July 2009, enabling banks and corporations in a number of mainland provinces to settle payments with trading partners in a number of countries, initially largely focused on south-east Asia, in renminbi.
The scope of this pilot scheme has since been extended to include many countries in south-east Asia, as well as a number of ‘friendly’ jurisdictions further afield, such as Venezuela and Argentina. According to the PBoC (People’s Bank of China), banks had settled RMB509.3 billion ($77.8 billion) worth of trade in the Chinese currency by end-December last year.
Offshore yuan bond issuance is part of this process. A March 31 report by Singapore’s DBS Bank found that the Chinese government is the biggest issuer of dim sum bonds, raising RMB14 billion in the 15 months to end-2010.
China’s determination to expand the global role of its currency is also financially pragmatic. Beijing, notes ANZ in a March 2011 report, is desperate to offset huge capital flows into the mainland (which are helping drive up producer and consumer prices) by promoting the use of the RMB as an invoicing currency for international trade.
The report notes that a stronger and more assertive yuan would also “help boost domestic consumption” (vital to helping rebalance China’s export-dependent economy) while managing the effects of imported inflation.
INITIAL FOCUS
In the near term, the RMB’s international expansion will happen locally in Asia-Pacific, and in selected ‘friendly’ jurisdictions further afield.
Close to home, drivers of the RMB as an offshore currency are nations that trade extensively with China, fuelling its economic braziers. This list includes Australia, a major supplier of minerals and energy, and Malaysia and Indonesia, key suppliers of coal and food resources.
“While an exporter in Australia for instance will not switch immediately to RMB offshore, they all have the aim of setting up an account and trying it out,” says ANZ’s Plante. “They want to understand the market, to be ready and prepared.” Further afield, China’s sovereign allies include Hugo Chávez’s Venezuela, which is developing new offshore oil fields with drilling and pumping equipment bought in RMB. In return it will ship billions of barrels of oil to the mainland over the coming years. Thus China is creating a relatively closed system with its circle of friends, with the yuan at its centre.
GOING GLOBAL
Banks, however, are anticipating a more global, open market for the yuan, and are widening their range of RMB-related products. Basic working products such as receivables and trade settlement services are increasingly popular as, on the risk management side, are spot and forward transactions, options, derivatives and interest rate swaps.
ANZ’s Plante says that the Australian lender recently completed a tour of the United States, designed in part to promote the RMB as an offshore currency, and was struck by the response. “Every customer of ours in America wanted to talk about it,” he notes. “It showed that you can’t afford to not know about China’s currency these days.”
SIGNIFICANT OBSTACLES
Despite all the froth and fervour, a plethora of obstacles need to be overcome before China’s legal tender can become a true global reserve currency.
For a start, the renminbi is hardly a liquid market. Standard Chartered’s Daswani notes that current liquidity levels are still considered to be “too small” to support equity and even debt trading in the RMB.
More fundamentally, doubts remain about the viability of a global reserve currency when the host nation remains reluctant to process transactions onshore in its own currency. Serious international legal tender through history, from Rome’s denarius to the US dollar, has started life at home before branching out into the world. China, with its offshore approach, is doing everything in reverse.
To be sure, this is pragmatic on one level – it allows Beijing to trial the international impact of its currency without disturbing fragile economic and fiscal stability at home. But its continued reluctance to countenance full exchange rate convertibility or to dismantle its complex system of currency controls belies concern about the sustainability of the domestic economy, and is holding back the genuine international adoption of its currency or deepening of its markets.
Furthermore, the timing of full convertibility appears to remain a long way off. Even normally bullish bankers see full convertibility – and thus the creation of a proper working Chinese currency – as some way off. The RMB will only take off, notes ANZ’s Plante, when trust has been established.
“That means that the current account must be fully opened, with no such thing as an onshore and an offshore market,” he says. “I can foresee a time when the RMB is used by global multinationals to settle transactions all the time, as the US dollar, euro or Japanese yen are used today. But that will take a long time – 10 or more years I would say.”
HYPE OR REALITY
Some critics therefore suggest that banks and the Chinese authorities are over-hyping the significance of efforts to internationalize the renminbi, given that volumes and liquidity remain small and significant hurdles remain.
These include the fact that China’s banking sector remains largely state-owned, interest and exchange rates are not market-based and that its capital account remains closed.
Nevertheless, despite the host of intangible “ifs” and “buts” that remain unresolved, most market participants remain convinced that the Chinese currency will continue to become a key trading currency settling transactions in Asia-Pacific and beyond, and that the internationalization of the renminbi will continue apace.
“I have no doubt that the RMB will become a global currency,” says ANZ’s Plante. “The strength of the RMB market has taken a lot of customers by surprise. It will be one of the great stories over the next 20 years.”