China has seemingly managed the impossible: making a partially convertible currency an increasingly commonplace tool of global trade and finance. As a means of trade settlement, the RMB has gone from a timid start to the seventh most important payment currency globally, according to Swift. It's now hot on the heels of the Canadian and Australian dollars, ranked sixth and fifth, respectively.
On the investment side, despite the many restrictions still in place, initiatives such as the qualified foreign institutional investors (QFII) programme and its RMB-denominated version, RQFII — which allow foreign investors controlled access to China's domestic capital markets — have grown to $115bn in just over a decade. Overall RQFII quotas, in particular, have doubled in size in 2014 alone, to Rmb300bn ($48.5bn).
The Shanghai-Hong Kong Stock Connect launched last November, allowing cross-border trading of select equities listed on the two cities’ exchanges and pushing the RMB internationalisation agenda one step further. Despite a slow start, the programme has seen average daily turnover of Rmb5.6bn and HK$929m for its northbound and southbound channels, respectively.
The RMB, then, is finally starting to make some progress towards what many believe is China's ultimate goal — the redback as a global reserve currency on a par with the dollar. As of last year, around thirty central banks around the world already held some level of RMB reserves, according to the People’s Bank of China. Another 10 are thought to be preparing to do so.
What could possibly be missing? If there is a potential obstacle on the path to RMB internationalisation, it lies not so much in the volume cross-border usage — which is rising all the time — but in the direction of those flows.
Firstly, programmes like RQFII effectively represent a growing channel for the repatriation of RMB-denominated capital into China, rather than for the accumulation of RMB outside of the country. Secondly, the Stock Connect, which theoretically envisions similarly sized flows of investment in and out of the country, has been much more successful as an A-share purchase vehicle rather than the opposite. So much so, that by January 13 the programme had already transferred some Rmb67bn into the mainland.
The pool of offshore liquidity is likely to keep growing on the back of stronger RMB-denominated trade flows, with RMB deposits in the nine top global hubs nearing a sizeable Rmb2tr as of last year. But Chinese authorities will need to be watchful. The recent patch of RMB depreciation against the dollar and its increasing volatility will mean that what had once seemed like a great call — switching China trade into RMB — is suddenly looking a lot less appetising for foreign counterparties.
Analysts warn that the trend for a weaker, more volatile RMB, coupled with the growth of schemes that make the purchase of onshore assets easier, could have a remarkably chilling effect on the growth of offshore RMB.
Flying the nest
As far as the foreign exchange conundrum is concerned, the central bank has been increasing the trading band and advertising its desire to let the market play a more decisive role in the RMB’s value. But on the investment side, the recent launch of the RMB qualified domestic institutional investor programme (RQDII) could well be used to counter, if not reverse, some of those constraining forces.
The programme – which allows qualified domestic investors to purchase offshore RMB assets such as dim sum bonds issued in Hong Kong, could play a vital role in stimulating more overseas issuers to consider RMB as a funding option, backed by the confidence that large Chinese investors may now be able to invest in those deals. To make sure that happens, regulators would be well advised to make participation in the scheme as simple as possible.
But help could come from another source, too. The International Monetary Fund (IMF) is set to play this year a decisive role in the RMB’s future as a reserve currency. Its five year review of the basket of currencies backing its special drawing rights (SDR) facility could see the RMB added. That would act as a blessing for more central banks worldwide to start accumulating the currency in their reserves much more actively.
The healthy growth of the RMB as an international currency ultimately relies on establishing healthy two-way flows of capital. RQDII, and the IMF, might just help stabilise those flows a little more this year.