The past, present, and future of international currency dominance
Those slides come via the World Bank’s big report last week about the expected rise of the six largest emerging markets. The report featured an extended section on the future of international currencies, but we’ll focus here on the RMB.
As we said in January, it will take some time for the RMB to become a truly global currency. But China’s efforts to move in that direction continue apace, and a new paper from RBC Capital Markets gives a useful update of the gains made this year.
In simplified terms, this is what the process of RMB internationalisation will look like, at least if China has its way:
Stage 1 has been for the government to allow more of China’s cross-border trade to be settled in yuan, usually in the form of domestic Chinese manufacturers paying for imports from their foreign suppliers (though budding Chinese trade with Africa is proving an interesting exception). These transactions are settled in Hong Kong accounts, thus increasing the amount of yuan in circulation offshore; these offshore yuan are referred to as CNH rather than the onshore CNY.
As foreign companies and investors thus accumulate more yuan, they’ll also look for vehicles in which to invest them — which is Stage 2, more on which in a moment.
But as for Stage 1, so far so good:
This recent increase is mostly the result of Chinese authorities expanding the number of companies with permission to conduct trade in yuan, with the Q1 total of CNY360bn (roughly the equivalent of USD55bn) representing 7 per cent of total Chinese merchandise trade, up from roughly 3 per cent for the full year 2010.
Because of stringent controls that restrict the flow of yuan back onto the mainland, these accumulated yuan typically remain on deposit in Hong Kong banks. Some numbers from RBC:
These deposits have increased to around CNY450 billion at the end of March, up from CNY280 billion just three months earlier and from less than CNY100 billion mid-2010. Further expansion of yuan trade settlement will likely drive continued strong increases in these deposits, with officials recently estimating they will double to almost CNY900 billion by the end of the year.
Naturally, for want of other options, Hong Kong has also emerged as the preferred investment destination for offshore holders of yuan — with the nascent offshore bond market in particular growing quickly.
The CNY46bn issued year to day already surpasses the CNY36bn issued during all of 2010, and the past two months have been especially active after mainland officials cut the benchmark interest rate on offshore yuan deposits.
As for who is doing the issuing, domestic banks capitalising on low funding costs account for roughly half of the total supply outstanding. But the list includes the familiar names of multinational corporates such as Volkswagon, Unilever, and Caterpillar, who use the low rates to finance their Chinese operations on the mainland:
Curiously, and certainly not coincidentally, the Chinese government issues some of its sovereign debt in the offshore market, where rates for the 10-year have recently been some 200 bps cheaper than for the onshore bond.
But that’s roughly the extent of progress on Stage 2, and Stage 3 (international reserve currency) certainly remains an ever more distant goal. Because at the moment, there remain few viable options for investing CNH outside of the small offshore bond market — controls on the Chinese capital account remain too restrictive.
But there are has been some progress in other avenues, so let’s take a quick survey:
— Synthetic bonds, which are denominated in CNY but settled in USD, are sometimes issued by mainland Chinese property developers. Strangely, there are fewer restrictions on remitting the dollars from these bond sales to the mainland than would exist on yuan raised through CNH bonds. But regulators are trying to limit the flow of money to the property sector, and recently issuance of these bonds has dried up.
— On the use of CNH for FDI in the mainland, here’s RBC:
Remitting funds requires specific approval from Chinese authorities on a case-by-case basis, and this approval can take several months to secure. The ease with which permission is granted will also depend heavily on what the funds will be used for and the extent to which their proposed use is consistent with Beijing’s broader policy objectives.
— Portfolio investment also remains tightly restricted, though recently there have some minor changes. The most notable has been the opening of the onshore bond market to foreign banks:
Last year it was announced that approved banks that accumulate funds offshore as the result of trade settlement can then use those funds to buy Chinese bonds. Five banks received this approval by the end of last year, with another twenty approved so far this year. Each bank is subject to a strict quota on how much can be invested, but this development represents an important step in opening up China’s financial markets to greater foreign participation and should stimulate the flow of yuan in and out of the country.
— As for offshore equities, there’s only one company listed in Hong Kong that’s denominated in RMB: Hui Xian, which had its (disappointing) IPO in late April.
— A “mini-QFII” scheme could allow some foreign central banks, mainly from nearby Asian countries, to start building a limited amount of currency reserves even before anything like full currency convertibility can be contemplated. QFII stands for Qualified Foreign Institutional Investor, a designation that allows a company to invest in Chinese bonds and equities — though again, within strict limits.
Chinese regulators are contemplating a similar scheme that would allow financial instituions with a physical mainland presence to remit CNY from their Hong Kong subsidiaries back to the mainland — and, potentially, foreign central banks to invest small amounts of yuan in the Chinese interbank bond market.
The Hong Kong Monetary Authority already has QFII status, and the Monetary Authority of Singapore has applied for it. Officials from the Bank of Korea and the Central Bank of the Philippines have also expressed interest in eventually holding yuan reserves.
We’ll see. There’s been progress made on all of these fronts, but it’s also clear that Chinese authorities are determined to proceed at a steady, gradual pace. And meanwhile, such predictions of eventual currency dominance also depend on the persistent, long-term strength of the Chinese economy itself. After all, similar predictions applied to other countries have failed to come to fruition — see: late 1980s, Japan.
Full report in the usual place.