Use of the US dollar as a settlement currency has long hindered both mainland Chinese companies and their overseas trading partners. But bankers expect the series of regulatory changes by China’s central bank, the People’s Bank of China (PBoC), to significantly encourage growth of both the international renminbi trade settlement programme and renminbi liquidity in Hong Kong.
Specifically, the policy change announced in August makes it easier for overseas participating banks (ie, banks originating and receiving payments for companies trading with Chinese firms) to access the mainland’s interbank bond market. The development follows a series of policy changes over recent months, including the July circular from the Hong Kong Monetary Authority (HKMA) encouraging the development of renminbi-denominated financial market products and investment instruments.
These policy changes do not affect China’s strictly controlled capital account regime, but they still mark an important step towards eventual liberalisation of the currency, say the banks, and will spur growth in offshore trade settlement. For instance, more access by foreign lenders to the onshore interbank bond market extends renminbi use beyond trade-related transactions, and will result in a greater variety of renminbi-denominated investment products with different yield curves to meet market needs.
“The recent regulation permits renminbi exchange for general purposes by enabling participating banks to square their FX positions through the interbank FX market in Hong Kong,” said Neil Daswani, head of transaction banking, Northeast Asia for Standard Chartered Bank. “The development of renminbi-denominated investment instruments in Hong Kong will also encourage corporates to accept and hold renminbi positions, which is important for building up offshore liquidity and facilitating its circulation outside China.
“While this provides flexibility for corporates to manage their FX positions, they should also be aware that the renminbi FX interbank market is at its infant stage so the general market demand is on buying renminbi; thus the pricing may not be optimal at this stage compared with the onshore FX market in China,” said Daswani.
Foreign central banks can already use renminbi as a reserve currency through numerous bilateral currency swap agreements and renminbi settlement. “The problem is that the return of holding renminbi is low or even zero,” said Minggao Shen, Citigroup’s head of research for China. “They will be better motivated to do so if returns on renminbi assets are attractive. The size of renminbi reserves will still be subject to the scale of currency swaps at the moment. This cap would have to be removed to further internationalise the currency.”
Despite its nascent stage, participating banks predict significant pick-up in renminbi trade settlement activity, perhaps unsurprising given the mainland’s status as the world’s second largest economy with annual trade of around $2.8 trillion. “We believe renminbi liberalisation will gain momentum beyond the current fast pace of development, spurred by the greater interest from overseas parties attracted to this much larger market supporting renminbi circulation,” said Mark McCombe, HSBC Hong Kong chief executive officer.
PBoC has already reported half-yearly growth in global offshore renminbi trade settlement volumes, from Rmb3.6 billion in the second half of 2009 to Rmb70.6 billion in the first half of 2010. “We don’t know what will happen in the second half of this year, but I think it is a conservative estimate to say that we will see growth of another Rmb70 billion or so,” added Jens Scharff-Hansen, Deutsche Bank’s co-head of FX trading, who sees trade settlement as the key driver of renminbi liquidity in Hong Kong.
Contrast the growth of liquidity derived from the renminbi trade settlement programme with that derived from retail deposits. In May 2010 the HKMA reported total renminbi retail deposits – first introduced back in about 2003 -- of Rmb84.7 billion. HKMA now reports an aggregated total of Rmb103 billion, though this includes non-retail deposits.
“While corporate treasurers may not see much immediate impact [from renminbi liberalisation], they are starting to be asked about using renminbi, and will have to decide at what point to adopt it. For most, it is currently a wait-and-see approach, but as liberalisation proceeds it will become more urgent,” said Richard Brown, BNY Mellon head of treasury services, Asia.
The flip side of currency internationalisation is that the presence of large pools of renminbi offshore would greatly increase capital flows, thereby weakening the Chinese government’s credit and monetary controls. This is something about which China remains very wary, and it makes accurate predictions of the pace of currency reform impossible.
In addition, with total renminbi trade transactions of Rmb20 billion in 2Q2010 paling into insignificance besides the Rmb8.7 trillion of renminbi bonds issued in China in 2009, one sizable mainland bond issuance could account for the very limited pool of offshore renminbi liquidity.
“We have already reached a stage where even if there are no further changes, this market has the potential to mature very quickly, simply because China is the second biggest economy in the world with import-export numbers of $1.5 trillion,” countered Deutsche Bank’s Scharff-Hansen. “Even if you only have a percentage settled in renminbi in Hong Kong, whether it’s 5% or 10%, this is going to create a very big liquidity pool very quickly.”
Scharff-Hansen also identifies the interest rate differential as the other key driver of liquidity in Hong Kong. “Subject to the spot price, the renminbi settlement story can benefit all parties. It can benefit importers and exporters because it reduces FX costs, it can benefit exporters in Hong Kong because renminbi here will be unlikely to trade below renminbi on the mainland, and it could benefit importers into Hong Kong because, on a forward basis, they can buy renminbi at a better rate.”
