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Finance
26
September 2014
A PLUS
EXCHANGE
of
IDEAS
China is attempting to internationalize the yuan by
signing bilateral deals, encouraging its use in the
settlement of trade and broadening the range of
financial products available. George W. Russell
asks experts about the future of the world’s
seventh-most traded currency
Illustrations by Harry Harrison
A
fter more than two decades working in the Mainland, Jimmy Leung knows all the quirks of the renminbi, China’s “people’s currency,” also known as
the yuan. He remembers the currency confusion
of the 1980s caused by multiple exchange rates:
the official rate, the market rate and the black market rate.
He also recalls the 1990s, when non-citizens had to change hard
currency for used foreign exchange certificates at the Bank of China
and use them at designated outlets such as hotels and the infamous
state-owned Friendship Store chain.
“You did not want renminbi in Hong Kong in those days,” says
Leung, now China Banking and Capital Markets Leader with PricewaterhouseCoopers in Shanghai and a Hong Kong Institute of CPAs
member. “Nobody wanted it.”
But like many observers, Leung believes today that the renminbi
is on an unstoppable path to becoming a major world currency.
There are many reasons to welcome the ability to invest and
trade in yuan, Liu Linan, Greater China Rates and Foreign Exchange
Strategist at Deutsche Bank in Hong Kong, wrote in a recent report
tracing the currency’s internationalization. “Currency risk can be
neutralized by raising capital in the offshore renminbi bond market to fund onshore subsidiaries.” Yuan bonds also offer a relatively
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competitive source of financing and the potential to tap a new investor base. “Invoicing
goods in yuan for Chinese buyers may provide competitive advantages and the potential for significant cost savings,” Liu noted.
The most obvious growth of the yuan is
in international trade settlement. At the end
of 2013, the yuan was the eighth-most used
currency in terms of value, behind the U.S.
dollar, the euro, the pound sterling, the Japanese yen, the Australian dollar, the Swiss
franc and the Canadian dollar. (It had overtaken the Canadian dollar by June this year.)
It is likely to rise higher. Last year, the
yuan became the second-most used currency
in global trade finance – letters of credit and
bills for collection – after the U.S. dollar, according to the Society for Worldwide Interbank Financial Telecommunication.
Moreover, many countries are eager to
enter the offshore yuan trade: Beijing has
signed numerous bilateral currency swap
deals in which the central banks can supply each other’s currencies without a delay.
These will create more yuan liquidity overseas and reduce transaction costs by eliminating the need for converting into a third
currency.
Treading carefully
Leung at PwC expects China to extend the
reach of the yuan in a cautious manner, firstly
aiming to encourage more availability outside China before it expects any worldwide
role. “In the short term, the objective of the
government is clearly to internationalize the
currency,” he says, “but it is far from being a
global one.”
While the yuan assumes more importance as a medium of exchange, it lags far behind as a future reserve currency. “To be a reserve currency, you need a flexible exchange
rate, an open capital account and deep financial markets so foreign investors can actually get hold of renminbi-denominated assets
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and can move relatively freely in and out of
them,” insists Eswar Prasad, a former head
of the China desk at the International Monetary Fund. “In all these dimensions China is
not there yet.”
“Signing a bilateral
swap is a symbolic
yet significant
gesture from the
central banks.”
However, the nation is moving in the
right direction. Tim Pagett, Financial Services Industry Leader at Deloitte China in
Hong Kong, notes that earlier this year, the
Central Bank of Nigeria announced it would
increase the renminbi’s share of its currency
reserves from 2 percent to 7 percent. “We
feel that the renminbi will slowly start becoming a strong and viable option as a reserve currency,” he says.
According to data compiled by Standard
Chartered, at least 30 central banks have
already invested in renminbi assets: about
10 central banks hold renminbi as part of
their reserve portfolios, and another 20 or
so have signed the local currency swap lines
with the People’s Bank of China to create
renminbi liquidity.
Such swap deals also have a wider meaning. “Signing a bilateral swap is a symbolic yet
significant gesture from the central banks
on their acceptance and support to the renminbi,” says Pagett. “This provides a positive signal to the industry on the renminbi’s
acceptability for settlement and financing
purposes.”
Despite such international attention, Hong
Kong is expected to remain the priority offshore yuan market. “It’s a part of China, it has
a lot of transactions already, there are lots of
Chinese banks in Hong Kong,” says Walkman Lee, a Financial Services Partner with
KPMG China in Beijing and an Institute
member.
Since 2009, Hong Kong has seen a rapid
growth in yuan deposits, notes Vijay Chander,
Executive Director for Fixed Income at the
Asia Securities Industry & Financial Markets
Association. He also points to strong demand
for so-called dim sum bonds, yuan-denominated bonds issued outside the Mainland.
In the first quarter of 2014, 29 new dim
sum bonds totalling US$6.5 billion were issued, almost triple the same period last year,
according to London-based data provider
Dealogic. “Hong Kong will cater to the needs
of domestic Chinese issuers wishing to issue
dim sum bonds for many years to come,” says
Chander.
Competing cities
However, Hong Kong does face increasing
competition. Thomas Gilles, Head of the
China Desk at the Baker & McKenzie law firm
in Frankfurt, says the currency swap deal
between Germany and China “opens up
possibilities of new capital market products,
such as dim sum bonds issued” directly in
Frankfurt.
Rival financial centres are playing to their
own strengths as they seek to peck away at
Hong Kong’s current near-monopoly on the
offshore renminbi market. Gilles points out
that Germany is China’s largest trading partner and Frankfurt is its financial capital so
they have advantages.
Other cities have their niches, large and
small. “London is a major world financial
centre with a lot of bond issues and also, by
a large margin, the largest centre for the settlement of foreign exchange transactions,”
says Andrew Carmichael, a Partner with the
Linklaters international law firm in London.
“Luxembourg is the largest asset manager for funds and mutual funds in Europe,
and Singapore is the private wealth centre
in Asia, while Hong Kong is more China ori-
A PLUS
entated,” he adds. “If the renminbi is to be a
global currency, London, Luxembourg, Singapore and Hong Kong want to play their
parts in that.”
The increasingly cross-border nature of
the yuan trade, adds Leung at PwC, is a reflection of the Chinese economy’s opening
up. “After 2000, there were a lot of changes,” he says. “China’s accession to the World
Trade Organization in 2002 meant there
were a lot of commitments in terms of opening up to other parts of the world, including
the currency.”
The Chinese government has also become more open about its regulation, Leung
adds. “Fifteen years ago you heard nothing
from PBoC, you heard nothing from the
Ministry of Finance, about their thoughts or
their participation in the global economy.
You heard absolutely nothing about currency
policy. It was very opaque.”
This increased transparency makes the
renminbi a viable option as central banks
seek an alternative to the U.S. dollar for its
foreign exchange holdings. More recently,
it seemed the euro’s default position as the
world’s second reserve currency has been
shaken.
“The euro was seen as a prime candidate
for those seeking alternatives to the dollar,
but it has unfortunately faced its own share
of uncertainties arising from the debt crisis,”
points out John Zhu, Greater China Economist at HSBC. “This has led to increasing
interest across the world in holding non-traditional currencies [and] many global investors are increasingly seeing the yuan as an
alternative.”
Into the unknown
It could take some time. Peter Zöllner, Head
of the Banking Department at the Bank
for International Settlements, told a
March conference that the proportion of
“If the renminbi
is to be a global
currency, London,
Luxembourg,
Singapore and
Hong Kong want to
play their parts
in that.”
global reserves denominated in U.S. dollars might fall from between 65 and 70 percent to between 50 and 60 percent over the
next 20 years, with the yuan accounting for
perhaps a third to a half of the substitution.
Such moves, of course, are unlikely to
threaten the greenback’s primacy. “In the
short term, the U.S. dollar remains the
major reserve currency and there’s a long
way for the renminbi to go,” says Lee at
KPMG. “They have to prove to the world that
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they’re as stable as the U.S. dollar.”
In the meantime, the Chinese government
is expected to continue to drop hints as to the
likely direction of the yuan’s internationalization. “Developments in the Shanghai and
other free trade zones will give some clues as
to the Chinese authorities’ thinking in terms
of the degree of freedom they are willing to
consider or contemplate with regard to capital movements into and out of China going
forward,” says Chander at ASIFMA.
He sees only increased use of the yuan
in trade and more central banks and fund
managers invest in yuan assets. “Finally,”
Chander adds, “there will be the convergence in both forex and interest rates between the onshore and offshore markets,
leading to a de facto convertible currency
even if de jure capital account convertibility
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September 2014
“In the short term,
the U.S. dollar
remains the major
reserve currency
and there’s a
long way for the
renminbi to go.”
in China is some way off.”
CPAs involved in treasury and risk management are reminded to be aware of the
complications surrounding the increased
use of the Mainland currency. “You have to
think about how to hedge the currency risk,”
says Lee, adding that although many Hong
Kong accountants are already familiar with
the yuan. “I think some companies want to
use it as a settlement currency because they
know how to manage the currency exposure.”
The main risk, say experts, is that the
yuan is not really freely convertible and the
PBoC sets the rate. “It’s very different from,
say, the Australian dollar or the euro, where
you have a mechanism,” says Lee. That creates a management risk. A company might
want to establish a separate procedure to
look after the fluctuation of the renminbi.”
So when will we expect to see a more
liberalized yuan environment? Experts say
the time when it bypasses or even becomes
comparable to the U.S. dollar is unknown. “I
really cannot tell,” says Leung at PwC. “The
important factor is full conversion of the
currency, and for that, nobody can predict a
timetable.”
A PLUS
Monetary milestones
1948 First renminbi or “people's currency” issued by
newly founded People's Bank of China. It is also
known as the yuan.
1949
Yuan becomes sole legal currency.
1955 Exchange rate set at 2.46 yuan to the U.S. dollar.
1960s-70s Yuan stable in terms of inflation, as government
sets wages and prices in centrally planned economy.
2005
C
hina shifts from a decade-old peg against the
dollar to a managed float, based on a basket of
currencies. It devalues the yuan by 2.1 percent
overnight to 8.11 against the dollar.
2007 T
he first yuan-denominated bonds are sold in
Hong Kong.
2008 China pegs the yuan against the dollar at 6.83 as
an emergency measure to help stabilize China's
economy amid the worsening global financial
crisis.
1971-78 Yuan gradually revalues to 1.50 yuan to the dollar.
1979 As China opens its economy, exporters are allowed
to retain a percentage of foreign exchange.
2009 China launches trial programme allowing companies in select cities to settle imports and exports
in yuan, naming Hong Kong the pilot city for yuan
settlement outside the Mainland.
1981 First round of yuan devaluation. State Council introduces "internal settlement rate" of 2.80 yuan per
dollar. The more realistic exchange rate is based
on China's average export cost per dollar plus a 10
percent margin.
2010
(June) 1983 State Council decides the PBoC should function
solely as central bank, not a commercial bank as
well.
China ends a two-year-long peg to the dollar,
returning to a managed float based on a basket of
currencies.
2010
(July)
China's central bank and the Hong Kong Monetary
Authority agree to expand the scope of yuan
clearing in Hong Kong and offshore yuan trading
takes off.
2010 (August)
McDonald's becomes the first nonfinancial
foreign company to issue yuan-denominated
bonds in Hong Kong.
1985 Internal settlement rate abolished. China sets rate
at 2.80 yuan to the dollar, ending dual exchange
rate system.
1990s Exporters suffer increasing losses because of the
yuan's overvaluation.
1993 U.S. Treasury labels China a currency manipulator
for first time.
2010 China allows select exporters to keep some of
(October) t heir foreign-currency earnings offshore in a trial
programme.
1994 China unifies its dual exchange-rate system by
(January) moving the official rate of 5.80 to the dollar to the
prevailing market-determined rate of 8.70, devaluing the yuan by 33 percent overnight.
2011 C
hina launches a pilot programme to let domestic
(January) companies use yuan for investments outside
China.
1994 (April)
1996 F irst foreign exchange trading centre opens in
Shanghai, starting China's inter-bank foreign
exchange market. Yuan rate is set around 8.28
yuan per dollar as part of a tightly managed floating
exchange rate policy.
China allows the yuan to be fully convertible into
foreign currencies for trade purposes but maintains rules and limits on buying and selling foreign
currencies to make loans and investments.
2011 (April) ong Kong-listed Hui Xian Real Estate Investment
H
Trust becomes first yuan-denominated initial
public offering outside China but falls sharply on
its debut.
2012
Cross-border trade settlement scheme expanded
(March) to all Chinese companies with import or export
scope on their business licenses.
2013
Shanghai Free Trade Zone is set up to test an
(September) offshore yuan market in Shanghai.
1997-99 Y uan is pegged at 8.28 to the dollar through frequent central-bank interventions.
2013
China settles 20 percent of trade in yuan, up from
zero in 2008.
2002
hina begins to relax its capital controls gradually
C
after joining the World Trade Organization, but
international pressure mounts for China to let the
yuan appreciate faster to help balance global trade.
2004 hina allows Hong Kong banks to offer limited retail
C
yuan banking services to facilitate cross-border
tourist spending.
2020
Yuan will rank only after the U.S. dollar, euro
(forecast) a nd the pound sterling as the world's
fourth most-used payment currency
and 30 percent of China's trade by
then will be settled in yuan.
Sources: Deutsche Bank, EY, HSBC, Ministry of Finance, Standard Chartered
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