The gradual internationalisation of the RMB

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China is an economic giant. It is the world’s largest trading nation and is set to be the world’s largest economy as early as next year. Yet China’s financial relations with the rest of the world and the offshore use of the Chinese renminbi (RMB) is limited. While the RMB ranked 5th as an international payments currency in June 2019, its share of global transactions was less than 2 per cent. In contrast, the share of transactions in USD was 40 per cent and the Euro held 34 per cent.

In some respects, it is not surprising that the RMB has such low usage offshore. While China’s current account has been freely traded since 2009, the capital account remains largely closed with flows in and out of China heavily restricted. China has signalled an appetite to liberalise its capital account but the pace and sequencing of reforms remain uncertain.

The key feature of an internationalised currency is that it is widely used by both the private and official sectors outside the currency’s home country. This usually requires the currency to be used as a unit of account for trade invoicing, a medium of exchange for trade settlement and broader financial transactions, and a reliable store of value such as foreign exchange reserves.

Because China has widespread capital controls but an open trade account, it relies heavily on encouraging greater RMB trade invoicing. Substantial increases in the use of RMB for trade settlement will necessitate use for investment and the demand for RMB reserves will follow, albeit slowly.

The establishment of an RMB hub to facilitate RMB transactions requires the appointment of an official settlement bank for offshore RMB transactions, an RMB Qualified Foreign Institutional Investor quota for reinvestment back into China and a swap facility to support the settlement of RMB. The network of offshore hubs provides a framework to facilitate offshore transactions, complementing onshore market reforms and international milestones such as inclusion of the RMB in the International Monetary Fund’s (IMF) international reserve basket, the special drawing rights.

China has publicly acknowledged its plans to internationalise the RMB and significantly increase the offshore use of RMB, but the commitment to reform has slowed considerably over the last few years. If China wanted to push the process it would only need to insist that state-owned enterprises settle their trade in RMB.

China is grappling with a rapidly transforming economy and the internationalisation of the RMB is but one of its many political and economic objectives. China appears to be content to slow the timeline for internationalisation and allow the process to evolve gradually.

Without further policy intervention, there needs to be a clear upside for corporates to incur the cost of using RMB for trade and investment. The advantages may not be clear for countries such as Australia where most of the trade with China is one directional. Australia either sells to or buys from China so the drive to settle in RMB and have it sitting on the balance sheet is very low. Globally, products like iron ore are priced in USD. Considerable structural change is needed for a shift in the trade currency used.

China is not relying solely on the use of RMB in trade to push its internationalisation agenda. In recent years it has implemented programs to attract more inflows while still maintaining strong controls on outflows. A major innovation was the introduction of the bond and stock connect programs allowing international investors access — through Hong Kong — into Shanghai and Shenzhen. The bulk of the flows are northbound into China, reflecting China’s competing priority to restrict outbound flows.

The 2019 launch of the Shanghai London Stock Connect provides a different model where investors trade in depository receipts rather than direct ownership due in part to the significant time gap between the two exchanges.

These programs are a necessary component of the decisions by global index managers like the MSCI and FTSE and bond index managers like JP Morgan to increase China’s weight in their benchmarks. The IMF estimates that benchmark driven portfolio inflows could reach US$450 billion over the next three years. On the surface this seems like a major step in the internationalisation of the RMB and the reform of China’s volatile equity market, but there are significant concerns around investor protection and uncertain regulations. These issues will not be resolved quickly.

It appears that the only strategies…

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