China certainly hasn’t been slow to promote the internationalisation of its currency. In its latest move this week, the Australian dollar has become the third currency to become directly tradable with the renminbi alongside the US dollar and the Japanese yen.
Yet China should not rest on its laurels and if it really wants to spread the use of the currency, it needs to be more ambitious. It’s next smart move would be to add the euro to that list too.
On April 10, China officially allowed direct trading between the renminbi and the Aussie dollar, marking the next important step in economic relations between the two nations. This was announced after Australian prime minister Julia Gillard visited the Mainland’s financial capital of Shanghai on April 7.
Although it makes sense for China – the world’s second largest economy after the US – to further enhance its bilateral relationship with Australia via this route, the adoption pace of the renminbi by Australian corporates will be limited. This is because majority of country’s trade is commodity-driven, a bulk of which is still denominated in US dollars.
Anecdotal evidence from some Aussie mining giants – such as Fortescue and Rio Tinto – even show that there’s little interest in adopting the Chinese currency until it ultimately becomes an invoicing denomination for commodities.
Given that direct trading between the renminbi and Aussie dollar is expected to be slow-go in the short- to medium-term, Chinese authorities should set a bigger goal for themselves: by tying-up the currency with one that has greater global presence and more outward looking companies.
The euro – the last G3 currency left standing on China’s checklist and also the third most commonly traded currency onshore – is an ideal candidate.
It makes sense after all, especially given the fact that the European Union (EU) and China have an important economic relationship. China is now the EU’s second trading partner behind the United States, while the EU is China’s biggest trading partner, according to the European Commission.
China needs to realise that the size of trade between its economy and the EU – which currently stands at well over €1 billion (US$1.31 billion) a day – offers much greater scope for the promotion of the renminbi than either Australian dollars or Japanese yen.
And unlike Australia and Japan – which are fairly insular countries – the pace of renminbi trade redenomination to and from countries in the EU will take-off at a much more rapid pace, boosting the currency’s presence in the global arena.
Additionally, corporates from the EU have been contributing extensively to the renminbi internationalisation story even without direct trading or the establishment of a clearing bank in their time zone. One of the reasons is because European companies are experts at managing several currencies in their treasury operations due to the recent history of having separate currencies. This is in contrast to their American, Japanese or even Australian counterparts, who are only used to managing one of two denominations.
This is supported by a Deutsche Bank survey of companies in the United Kingdom, Germany and the Netherlands last August, the trend of switching to the renminbi is particularly noticeable for small-to-medium-sized enterprises (SMEs). At that point in time 20% of companies carry out their invoicing in renminbi, with the remaining 80% stating that switching their invoicing over to the Chinese currency is already in the pipeline.
All these factors are perfect reasons to why China should establish direct trading between the renminbi and the euro. If this were to occur, the Mainland would be able to propel the currency forward, quickening the adoption pace of the renminbi in the trade settlement space.
However, it certainly takes two to tango.
China shouldn’t be the only party that ought to push for this. Efforts should come from the EU. One of the reasons Australia has succeeded is because treasurer Wayne Swan, has made public his desire for direct trading since July last year.
Perhaps someone from the European Commission should step up and start a dialogue with China, increasing the region’s efforts in securing a starring role in the renminbi internationalisation story. The announcement in November that Paris is keen to become the next offshore renminbi hub is an indication that the EU is indeed stepping up its game.
Behind the scenes, the banking community also played a vital role in sensationalising the recent development between China and Australia. ANZ released a report in December highlighting that the strong Australia-China trade link has provided a strong case for using renminbi in bilateral trade and investment. Other financial institutions were also highly anticipating this move.
This is one of the reasons why Swift highlighted in January that Australian companies are gaining momentum when it comes to the redenomination of their trade payments into renminbi, rising up the ranks from 12th position in November 2010 to fourth place in November 2012.
European corporates could also launch lobbying efforts – after all they are able to save quite a fair bit of money dealing in the renminbi. For example, MNCs would be able to improve their negotiating position with Chinese customers and suppliers if they were to adopt the Chinese currency in addition to being able to save an average of 4.8% per transaction as they have managed to remove the FX risk initially borne by the Chinese counterparty from the equation, highlights Deutsche Bank.
And if direct trading were allowed between the euro and renminbi, this removes the additional step of having to convert the payment into US dollars from the process, thereby reducing overall transaction costs further.
All in all, it’s a win-win situation for both parties. It makes a lot of sense for China to allow direct trading between the renminbi and the euro, and this development should not be delayed any further, especially if both nations are keen to reap the economic benefits that this partnership will bring.