China’s decision in April to widen its currency’s trading band against the dollar was seen by some as just one more step along the road towards a market-determined exchange rate. But others say it portends major changes in the regional and global role of the Chinese currency.
Beijing had already been moving to extend the international use of the renminbi, through currency swap and trade-financing arrangements with countries from Asia to Latin America and beyond. China and Japan have meanwhile agreed to use each other’s currencies in mutual trade transactions. China has also offered to extend yuan loans to members of the Brics (Brazil, Russia, India, China, South Africa) group.
The announcement by the People’s Bank of China (PBoC) on Apri1 14 that the renminbi would be allowed to fluctuate by up to 1% either side of the daily reference rate set by the central bank – which is twice the previous limit – needs to be seen in this wider context to grasp its true significance, experts argue.
IMF managing director Christine Lagarde promptly issued a statement welcoming what she called “this important step by the People’s Bank of China to increase the flexibility of their currency”. This, she said, “underlines China’s commitment to rebalance its economy toward domestic consumption and allow market forces to play a greater role in determining the level of the exchange rate”.
In a report published immediately after China’s move, HSBC described the renminbi band widening as “much more than a shift in policy away from appreciation to greater flexibility”. Rather it showed that Beijing “sees the present as the right time to push forward financial reforms”. HSBC advised its clients to “get ready for more fireworks in capital account deregulation, renminbi internationalization, domestic bond markets and banking reforms”.
China’s central bank governor and other senior PBoC officials have signalled their desire to speed up financial reforms. “Chief among these reforms is capital account liberalization. This will also be supported by further reform actions in areas such as renminbi internationalization, the domestic bond markets and in the banking sector,” HSBC noted.
Asian Development Bank chief economist Changyong Rhee says that Beijing’s latest currency move is “consistent with their recent efforts to liberalize financial markets and their foreign exchange market”, although he does not expect very drastic liberalization to happen soon.
Now is a good time for China to permit the renminbi to move more freely, says Rhee, because “China’s current account deficit in terms of GDP is declining, and with that trend, there is a good opportunity for them to be a little bit more aggressive in exchange rate liberalization.”
Any further appreciation in the renminbi exchange rate beyond the 5–7% annual appreciation against the dollar in recent years would help China orientate demand away from the export sector and towards the domestic market while also damping down inflationary tendencies, says Rhee.
DIFFERING VIEWPOINTS
Some say the renminbi is already close to its market equilibrium level and that further significant rate changes are doubtful. “The likely impact on major currency markets of China’s move will be almost nothing,” says Tohru Sasaki, chief foreign exchange strategist at JPMorgan Chase Bank in Tokyo.
But others take a longer term view. “Internationalization of the yuan is proceeding apace and appears to be on an accelerating scale,” William Thomson, a former executive director and vice-president of the ADB and now chairman of Private Capital in Hong Kong, tells Emerging Markets.
“Use of bilateral currency swaps, renminbi bonds and holdings of renminbi outside China are part of an effort to reduce the global system’s overdependence on the dollar,” he says. “China is now a global player with interests everywhere from the Middle East to Africa and Latin America. Promoting its currency is a timely aspect of policy as it moves to become the world’s largest economy in the near future.”
Former vice-chairman, Goldman Sachs (Asia) and co-founder of Themes Investment Management, Kenneth Courtis has a similarly upbeat view on the prospects for the renminbi. “Internationalization of the renminbi is happening fast, and across many fronts,” he tells Emerging Markets.
“I expect that by 2018 we will have a fully convertible renminbi. That does not mean, however, that we will have a freely convertible renminbi. The difference is a subtle one, but one that is important. Beijing will work hard to maintain broad control of capital flows, through various regulations, and through the process of conversion.
“Trends toward protectionism, managed floats, and the currency crisis we are seeing around the world only reinforce the view in Beijing that it is important and necessary to keep that distinction between fully convertible versus freely convertible. By the end of the year, I expect that upwards of 20% of PRC [People’s Republic of China] trade will be settled in renminbi.”
Within Asia, a little-publicized agreement (announced on Christmas Day 2011) between Japan and China to promote the use of each other’s currencies in settling trade transactions and to engage in mutual purchases of government bonds is described by Masahiro Kawai, dean of the Asian Development Bank Institute in Tokyo, as an important step forward.
“It is significant that leaders of the two largest economies in Asia and which are among the top three economies of the world have come up with such an agreement,” Kawai tells Emerging Markets.
“Asian economies are continuing to grow, and Asian currencies are going to continue rising, so from the perspective of monetary authorities, it would be useful to diversify away from the dollar, and to some extent the euro, into Asian currencies. The rest of the world will want to have more Asian currencies in their foreign exchange reserves.”
Japan is the first G7 country to be given permission to buy Chinese government bonds. (Only Australia, Malaysia and Singapore are permitted to invest in these securities, and the outstanding balance of such bonds held by foreign central banks or monetary authorities accounts for only 0.9% of the total, according to the Nomura Institute of Capital Markets Research.)
As China liberalizes its bond market and allows foreign authorities to hold renminbi bonds, “that will accelerate China’s capital account liberalization,” says Kawai.
“China and Japan are Asia’s dominant economies, and for them to start cooperating on the currency front will have a significant impact on Asian financial market development,” Noritaka Akamatsu, deputy head of the Office of Regional Economic Integration at the ADB, tells Emerging Markets.
“Between Asian currencies there just isn’t any direct foreign exchange market,” says Akamatsu. But “if the yen/renminbi market is deepened, that will provide cheaper costs and reduce exchange risks,” he says. The Sino-Japanese agreement, he believes, will create an environment in which this agenda can be pushed – and a major step forward.