While Japan and China have taken a symbolic step towards the internationalisation of the renminbi by announcing the direct trading of their two currencies, the concrete benefits of the deal will be minimal, at least in the short term.
Jun Azumi, Japanese finance minister, announced on May 29 that Tokyo and Beijing will start the direct trading of the renminbi and yen on June 1 as part of a broad deal agreed last year to strengthen bilateral financial ties.
The yen-renminbi exchange rate will be updated in real time in both the Japanese and Chinese markets. By avoiding the need to arbitrage between the dollar, banks can lower transaction costs and reduce settlement risks.
While this marks another stage of China’s journey to foster the Chinese currency’s use internationally, the deal is unlikely to trigger any dramatic surge of direct yen-renminbi trading. In order to see a material impact, the mainland still needs to do more and this will involve the full liberalisation of its capital and financial markets.
For example, a first essential step would be for China to loosen the leash on its currency control.
With the dollar/renminbi still controlled under a floating band of 1%, it is unlikely that trade in the Chinese currency in Tokyo is expected to soar in the near-term. And although the recent currency trade agreement stipulates that onshore yen-renminbi trade will be allowed to move within in a wider range of 3%, this is still a restriction imposed on the currencies which ideally should be market-driven.
According to a survey on April 2011 data by the Tokyo Foreign Exchange Market Committee, the average daily trading of renminbi in Tokyo only stands at US$350 million, mainly through non-deliverable forwards, typically used as a proxy for currencies that are not fully convertible.
That dismal number is compared to the average daily turnover of foreign exchange (FX) trading in the Tokyo market of US$284.6 billion – more than 800 times more.
Also, even though trade flows between Asia’s two largest economies are considered substantial – annual trade between China and Japan more than doubled to ¥27.5 trillion (US$350.1 billion) between 2001 and 2011 – dollar-denominated invoices continue to dominate trade transactions. Based on data from Japanese banks given to the Ministry of Finance, most of that is being settled in dollars, with less than 1% of it settled in renminbi.
Unless China takes more proactive steps making its currency convertible, the US dollar will continue to lead in trade settlement.
Clearing banks mandatory
Empirically it has been proven that a clearing bank is a must when it comes to expanding the liquidity of a currency in an economy.
If you take a look at Asia’s most active financial hubs – Singapore and Hong Kong, for example – the latter has a renminbi clearing bank. This essentially enables the Chinese government to be market makers in an offshore renminbi market through its designated bank, Bank of China (Hong Kong).
As a result, Hong Kong witnessed an explosion of renminbi liquidity and this became apparent when Beijing allowed the financial hub to lend in its currency in 2010, whereas in Singapore, the fact that the Monetary Authority of Singapore (MAS) has not revealed the estimated renminbi deposit base figure shows that the China currency’s liquidity is not sizeable.
For example, renminbi deposits in Hong Kong, the hub designated by Beijing to test the currency's internationalisation, rose to Rmb627.3 billion (US$99.06 billion) in November, a fivefold increase since July 2010. However, the deposits dropped to Rmb554.3 billion at the end of March as investors' appetite faded amid expectations of slower currency appreciation.
It is clear that the technical setup between Japan and China is still considered very immature compared with what they have with other countries in the region. And until Tokyo receives the green light from Beijing – in terms of establishing a clearing bank – we will not see a sizable surge in renminbi-denominated trade between the two neighbouring countries.
The other alternative other than to create a clearing bank is to establish direct bilateral agreements between the Bank of Japan (BoJ) and People’s Bank of China (PBoC). A good example would be to mimic the recent UK and China agreement in setting up London as the next potential offshore renminbi hub.
Although Japan currently has a multilateral agreement with China through the Asean+3 programme called the Chiang Mai Initiative (CMI), this is not sufficient. A direct bilateral agreement could encourage Japanese manufacturers and investors to engage in renminbi-denominated transactions, similar to other bilateral currency swap agreements that China has with Australia and New Zealand, for example.
The CMI is a multilateral currency swap arrangement among the 10 Association of Southeast Asian Nations (Asean) members plus its three major trade partners to the north (China, Korea and Japan). In May, officials of the Asean+3 agreed on doubling a regional currency fund meant to help in a liquidity crisis to US$240 billion, in a move that will strengthen the region's financial safety nets to help underpin sustainable growth.
Few argue against the idea that the renminbi will one day become a reserve currency, given World Bank predictions that China will overtake the United States as the world's top economy before 2030. But in order to achieve that, the renminbi would need to become fully convertible and Beijing has yet to indicate any timetable for reaching that stage.