Since late 2008, in response to the international financial crisis, China has intensified efforts to promote the RMB as an international currency for (1) trade settlement, (2) offshore financial markets and (3) direct investment abroad. Significant progress in the first two has already been made. It is not knownif China will go beyond limited forms of RMB internationalization. Although it would be good for China and good for the world if the RMB became a fully-fledged international reserve currency, competing with the dollar and the euro, it is not clear that China will take all measures necessary to make that possible. Beijing would have to remove many capital account restrictions and domestic financial controls that it currently employs for economic and political purposes, including the management of a repressed financial system. A limited role for the RMB as reserve currency is still possible, even in the absence of full convertibility. Malaysia recently invested a small portion of its forex reserves in RMB-denominated financial instruments, probably for political reasons and perhaps on the basis of a special convertibility agreement with Beijing.
RMB internationalization started in 2004 when Hong Kong residents were permitted to open limited RMB accounts with Hong Kong banks. By 2007 the amount of RMB on deposit in Hong Kong had grown sufficiently large to permit modest RMB bond issues in Hong Kong by selected mainland financial institutions. In 2010 that market was opened to many issuers in the PRC, including foreign corporations.For example, McDonald’s and Caterpillar issued so called ‘Dim Sum’ bonds toaccesslow cost offshore RMB for funding FDI in Mainland China. Even China’s Ministry of Finance has issued Dim Sum bonds.
The push to promote RMB as a trade settlement currency started in July 2009 when China permitted a limited number of mainland corporations and banks to engage in RMB-financed trade with Hong Kong on a trial basis. Hong Kong authorities were delighted to cooperate, thereby creating a new source of fee income for Hong Kong banks. The pilot scheme was significantly expanded in 2010 when over 67,000 firms in 20 Chinese provinces were licensed to engage in RMB-financed trade with all countries.
New initiatives toward RMB internationalization were announced recently: (1) Chinese firms are permitted to transfer RMB offshore for M&A and greenfield investments abroad and profits from such investments may be repatriated in RMB; (2) residents of Wenzhou, a prosperous, entrepreneurial city on China’s east coast, are permitted to use up to RMB200 million (about $31 million) per year for direct overseas investment; and (3) clients of Bank of China branches in London, New York and Canadacan open limited RMB saving and deposit accounts in RMB.
When the RMB trade settlement scheme was started in July 2009, the main motivation was undoubtedly to reduce dependence on the dollar as an invoicing and settlement currency for China’s huge external trade. Prior to the crisis an estimated 70 percent of China’s external trade was settled in dollars. The sharp decline in China’s exports in late 2008, following the collapse of Lehman Brothers, was not only caused by a downturn in final demand, but also by the global credit freeze, which made it hard for importers anywhere to get trade financing.Settlement in RMB protects Chinese exporters against currency risk and reduces their costs by eliminating the need for hedging.
China’sunhappiness with the present dollar-based international financial system is shared by many countries. Its decision to accelerate RMB internationalization initially led to a number of bilateral currency swap agreements between the People’s Bank of China (China’s central bank) and the central banks of South Korea, Malaysia, Belarus, Indonesia, Argentina, Iceland, Hong Kong and Singapore. Similar agreements were reached with New Zealand and Uzbekistan in April 2011, bringing the total value of bilateral currency swap agreements to RMB829.2 billion (about $127 billion at current exchange rates). China and Brazil agreed in principle to permit importers to use local currency to pay for imports from the other country.At a recent meeting of the four BRIC countries (Brazil, Russia, India, China) and South Africa the five heads of state agreed to promote the use of their own currencies for trade settlement between them. Seven percent of China’s foreign trade during the first quarter of 2011 was settled in RMB, up from 1 percent a year earlier. A paradoxical side effect of the use of RMB for import payments is that China’s foreign exchange reserves are growing faster than otherwise would have been the case.
The development of offshore RMB financial markets is a separate objective of RMB internationalization. The pool of offshore RMB deposits underpinning that market grew by 378 percent in 2010 to RMB408 billion (about $62 billion) by the end of February 2011. The two main sources of offshore RMB are payments in RMB for imports into China (about 80 percent) and RMB deposits by Hong Kong residents or mainland enterprises (about 20 percent). Because China has high growth, a current account surplus and strict capital account controls, developing an offshore market for the RMB is not easy.If it had not been for the widespread expectation of further RMB appreciation it would have been very difficult to push the RMB offshore and to keep most of it there.Onshore and offshore RMB markets have to be kept strictly separate through elaborate regulations governing the reflow of RMB to the PRC. As a result, interest rates and exchange rates on onshore and offshore RMB markets can and do differ. Interest rates in Hong Kong are at present lower than in Mainland China and the offshore RMB is normally worth a little more in dollar terms than the onshore RMB.
Negotiations between China and Singapore’s Monetary Authority to create a second hub for offshore RMB trading are ongoing. After Hong Kong and Singapore, Kuala Lumpur, Jakarta, Manila, Seoul (and eventually perhaps even Taipei) may be in line to serve as offshore RMB centers in Asia. Where all this will eventually lead is not clear at the moment.
Pieter Bottelier is an international economist, China scholar and consultant. He is an adjunct Professor at the Johns Hopkins University, School of Advanced International Studies