By Irina Slav, International Banker
In June, two European countries welcomed two Chinese banks as their official clearers for renminbi-denominated trades. In the UK it was the China Construction Bank and in Germany the Bank of China, respectively the second-largest and the largest Chinese financial institutions designated by Beijing to act as renminbi-clearers. Bankers and politicians in the two countries lauded the events, which marked one more step in China’s push to turn the yuan into one of the global settlement currencies. The world’s second-largest economy has been working on unleashing the renminbi for some time now and has already started reaping benefits.
In 2013, 18 percent of China’s global-trade settlements were done in renminbi, as opposed to just two percent three years earlier, according to information from the Society for Worldwide Interbank Financial Telecommunication, or Swift. This basically means that the Chinese currency overtook the Swiss franc as the seventh most widely used national currency in the world, Singapore’s Business Times notes. The daily forecasts that renminbi settlements will come to account for a third of China’s trade settlements by the end of next year and become fully convertible within the next two to three years. Optimistic as this may seem, there are indications that investors around the world are interested in renminbi-denominated trade and financial instruments. At the same time, some experts are skeptical when it comes to China’s ambition to integrate its economy more fully with the international framework.
One such skeptic is Barry Eichengreen, an economics professor at the University of California, Berkeley, who believes the renminbi is still very far from dethroning the US dollar from its top spot among international currencies. While he acknowledges Europe’s drive to diversify into other currencies, still feeling the scars with which the financial crisis left it, he doubts whether investor interest will be sufficient to advance the renminbi’s position. What’s perhaps an even more important consideration is the still insufficient depth of the Chinese market. In a piece for The Guardian, Eichengreen points out that, judging from historical examples, if China’s central bank decides to pull the reigns on its monetary policy, interbank rates will jump considerably, and those officially designated renminbi-clearing banks abroad would find it hard to get the amount of currency they are allowed under a set quota on cost-efficient terms.
In Europe, however, there is notable optimism regarding renminbi developments, as the continent is still trying to recover from a prolonged debt crisis, and the banking sector is finding itself increasingly stifled by post-crisis regulations. UK’s Chancellor George Osborne was clearly buoyant when he announced the designation of the China Construction Bank as London’s official renminbi-clearer, declaring this move will help the city take part in one of the rare cardinal changes in the modern financial world, as quoted by the Financial Times. Put simply, this move will allow London to take a bite out of an offshore renminbi market that has so far had just two players: Hong Kong and Singapore. But turning into a renminbi-clearing hub in Europe is all the more important for Britain after China’s ambassador openly said at the beginning of June that the country has lost much of its competitive advantage over other European countries. Signing the deal for China Construction Bank was one of the much-needed measures that David Cameron’s government had to take in order to improve its standing with China’s rulers and take advantage of the investment and trade opportunities offered by the world’s second-biggest economy.
Germany’s Bundesbank was also pretty upbeat about the People’s Bank of China’s decision to make Bank of China the designated renminbi-clearer in Frankfurt. In the press release following the event, Bundesbank’s executive board member Joachim Nagel noted that this is an important step in the direction of creating a renminbi-trading center in Europe, implying that Germany, like the UK, is ready to step into the renminbi-denominated financial market. What the setting up of these clearing banks means is that any transactions denominated in the Chinese currency will be settled directly, without needing to be redirected to Hong Kong or Singapore, which will reduce associated costs. But it will also mean that the designated banks will have access to renminbi liquidity in mainland China and to the payment system of the country. This is in fact the greatest advantage of these two banks that will now operate in Europe as renminbi-clearers: that unlike offshore financial institutions in Hong Kong and Singapore, they will be permitted to buy the currency directly from China, instead of having to bid for the limited supply of yuan traded outside the country, Barry Eichengreen points out.
Under an optimistic scenario, banks will start offering various renminbi-denominated instruments, expand the market and eventually put the renminbi, and along with it the euro and the pound sterling, on an equal footing with the dollar, which is at present the single universally accepted currency for traders the world over. But even if this scenario is to come true, it will take quite a bit of time, Eichengreen notes. China already had international markets worrying about its slowing economic growth, and there is no guarantee that the recent pick-up will be sustainable in the long run. What’s more, if the country starts having financial troubles, foreign capital will start flowing out, which will considerably pressure the attractiveness of the renminbi before it has succeeded in displacing the US dollar as a universal currency.
While Eichengreen’s arguments are logical, HSBC’s Renminbi International Study released in May this year revealed that the number of business leaders around the world who are increasingly interested in the Chinese currency is growing. The survey, carried out in 11 countries, showed that among the UK companies working in China, 86 percent planned to raise the portion of their renminbi-denominated deals. The same was true for 74 percent of business leaders from Canada, 73 percent from the UAE and 63 percent from France, as quoted by the Philippine’s BusinessMirror. The survey, which involved more than 1,000 companies doing business with China, found that just 22 percent of these are already using the Chinese currency for cross-border trade settlement. Of these, 58 percent used the Chinese currency in order to cut their risks or costs associated with cross-border trading. But aside from cutting risks and costs, trade in the local currency gives businesses much greater control over their cash flows by simply giving them direct access to the physical renminbi market instead of forcing them to resort to non-deliverable forward contracts (NDFCs), which is what companies with Chinese exposure in euros and dollars do. According to HSBC’s Global Foreign Exchange Division’s managing director, David Pavitt, NDFCs contribute to uncertainty as they are tied to offshore Chinese exchange rates, and these can vary greatly outside the margin of onshore rates, putting traders at a disadvantage.
As a counter point to Eichengreen’s doubts about potential interest in renminbi-investment options, Pavitt lists a number of offshore China instruments already available, including time deposits, renminbi equities, Dim-Sum corporate and government debt that often offer higher returns than dollar bonds, and Renminbi Qualified Foreign Institutional Investor funds. These latter vehicles provide investors with the opportunity to enter directly into the mainland Chinese stock market. Given all these attractive features – lower risk, greater cash-flow control, investment options – it is hardly surprising that interest in the Chinese currency is growing. What is interesting, however, is that the avant-garde is made up of smaller companies, the HSBC report notes. The reason is simple enough: There are large upfront costs for companies willing to take advantage of China’s opening up to the world, including accounting adjustments, new personnel and the development of new relationships. This is also the reason why many a large corporate firm is still reluctant to make an inroad into China, Pavitt says. They just need more time to be convinced that all the initial investment will be repaid, and China will not decide to take a U-turn on its renminbi-internationalization plans. Surprising as this may seem, this internationalization drive only started four years ago, so it is understandable that investor confidence is still at a budding stage. Still, HSBC believes that the yuan could become fully convertible by 2018. The Chinese state is not rushing to make its currency a global-payment currency; it is taking things slowly, which should give international corporate decision-makers ample time to get used to the idea that this internationalization of the yuan will provide them with more benefits than risks and disadvantages.