RMB arrives on global trade stage

Cross-border trade is driving the internationalisation of renminbi. But challenges remain if trade is to push the currency further beyond China’s borders. Rachel Evans reports.

  • 11 Jul 2011
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International trade is showcasing the power and influence of China like never before. China overtook Germany as the largest trading nation in 2010, pipped the US as the largest manufacturer in March and will usurp the US as the largest economy in real terms by 2016. China now wants to do business on its own terms.

The People’s Bank of China calculates that over Rmb500bn ($76.99bn) of cross-border trade was denominated in renminbi in 2010 — a shapr rise from around Rmb67bn in the first six months of the year, according to analysts at Credit Suisse.

And renminbi’s popularity as a trade currency shows no sign of abating. Chi Sun, a China economist at Nomura, calculates that Rmb300bn of foreign trade was settled in renminbi in the first quarter of 2011 — 60% of the total for the second half of 2010.

But as Chi notes: "This only accounts for 6.8% of China’s foreign trade in the first quarter, and only 10% of global trade involves China. So less than 1% of overall trade was settled in renminbi."

Renminbi can only compete with the dollar as the international trade currency if there is greater education about the benefits, better clearing systems and if China addresses the thorny issue of capital controls.

Learning curve

Renminbi trade first took off in July 2009 when China announced a pilot scheme that allowed Shanghai, Guangzhou, Shenzhen, Zhuhai and Dongguan to settle trade with Hong Kong, Macau and Asean members in renminbi. That programme was expanded to 20 provinces and any cross-border trade, regardless of provenance, in June 2010. The central bank now plans to take the scheme nationwide.

Renminbi trade settlement removes the exchange rate risk that Chinese companies face if they buy or sell goods in dollars. This reduces the cost of trade by removing the need to hedge currency exposure and supports China’s importers and exporters.

Cross-border trade will also help China battle inflation by decreasing the amount of money floating around its markets. "China struggles with excess liquidity and by encouraging renminbi-denominated trade, they can partly alleviate this problem," says Puay Yeong Goh, an FX strategist at Credit Suisse.

Companies must be approved as Mainland Designated Enterprises (MDEs) to participate in the trade settlement scheme. Some 67,359 were registered by December 2010, according to Credit Suisse, up from 365 companies in July 2009. But while onshore companies have embraced renminbi settlement, their counterparties need more education on the benefits of renminbi denominated trade.

Asian companies view China as the regional growth economy and see its currency as a more stable bet than the dollar. The picture is, however, rather different in some of China’s other big trading partners — such as Latin America.

"Latin America has more trade with China than ever before, so it’s puzzling that companies are not more interested in dealing in renminbi," says Chris Lewis, head of trade and supply chain for Greater China at HSBC. "A lot of it is down to education. Half way around the world the financial community may not have done enough to spread the word about RMB." Brazil, for example, prohibits foreign currency accounts.

None of the 901 Latin American importers and exporters surveyed by HSBC for its May 2011 Trade Confidence Monitor saw renminbi as a settlement currency over the next six months. Some 57% of the 300 Hong Kong companies surveyed, by contrast, thought renminbi would be a primary or secondary settlement currency, with 17% picking it as their number one settlement currency above the dollar.

"Some offshore companies do seem to be getting better trade terms if they agree to settle in renminbi as they are taking the foreign exchange rate risk out of the equation," says Steve Kelly, head of commercial North East Asia, global markets, at ANZ. But counterparties beyond Asia need to be told.

Clear responsibility

The system also needs tweaking in Asia. Bank of China (Hong Kong) and Bank of China (Macau) remain the only offshore clearing banks for cross-border trade, with all trades going through Bank of China before they reach the beneficiary’s bank account. Banks that provide the financing for eligible exporters and importers can also tap the onshore dollar/renminbi spot rate through Bank of China to square their trading positions.

These banks are highly exposed to Bank of China as a result and some began to approach their limits at the end of last year. "Many were concerned about the credit and concentration risk that banks in Hong Kong are building up against Bank of China (Hong Kong) in its role as settlement bank," says Andrew Malcolm, a partner at Linklaters. "It’s only a commercial bank so normal bank rules against concentration of credit risk apply."

The People’s Bank of China is, however, changing the clearing system to address this problem. Bank of China will help banks set up a fiduciary account alongside their settlement account. Cash that is not immediately required for settlement can be swept into the fiduciary account and this will be deposited with the Shenzhen branch of the People’s Bank of China. The money can be swept back to the settlement account when needed.

The money in the fiduciary account is protected in a Hong Kong insolvency as a result, limiting clients’ exposure to Bank of China. "This seems like a neat and clever solution to the problem," says Malcolm. "It should give offshore banks the ability to look through BOC to a direct claim with the central bank while still keeping settlement offshore."

Another solution to banks’ over-exposure to Bank of China would be to increase the number of offshore clearing banks. HSBC’s Asia Pacific chief executive Peter Wong recently said that his bank had a "high chance" of becoming a second clearing bank. And analysts at Credit Suisse also flag up plans for PBOC to approve more clearing banks in 2011.

Last year, Bank of China exhausted an Rmb8bn conversion quota to access the onshore renminbi/dollar spot rate to facilitate trade finance by October. The Hong Kong Monetary Authority was forced to step in, offering banks access to a Rmb200bn swap line it has with China’s central bank to help them square their positions. But banks did not take advantage of this facility, suggesting some used Bank of China’s access to the spot market for non-trade purposes.

HKMA issued revised guidelines in December as a result. Banks can only acquire renminbi from Bank of China for transactions that will settle in three months or less. Banks can only tap Bank of China if they have an overall deficit of renminbi as a result of trade. And banks must limit live deals to 10% of their renminbi book.

Bank of China was restored as the sole clearing bank at the beginning of January with an Rmb8bn annual quota, plus an additional sum that the PBOC sets on a quarterly basis. The bank has Rmb4bn for the first quarter.

Capital idea

But the main impediment to the development of renminbi as an international trade currency is the lack of viable offshore investments for international companies and banks. Both want to hold renminbi to take advantage of its appreciation but a shortage of investment opportunities makes it lazy money.

Deposits only earn around 0.4%-0.6% interest in Hong Kong but have grown to around Rmb450bn nonetheless and economists say this could hit Rmb1tr by the end of 2011. But investors are on the lookout for better ways to put their renminbi to work and the offshore renminbi bond market (CNH) has boomed as a result. These deals pay more than a deposit account but coupons remain small due to excess demand.

The central bank is, however, gradually loosening cross-border capital controls. PBOC has allowed some foreign banks to invest renminbi that they hold as a result of trade settlement in China’s Rmb20tr-plus interbank bond market. Standard Chartered, HSBC and Shanghai Banking Corp were given the first quotas in October 2010, and permission has since been extended to around 20 banks.

China is also planning a mini-QFII scheme which could further increase international access to the interbank bond market. Building on the success of the Qualified Foreign Institutional Investor scheme that China established in 2002, mini-QFII will allow domestic funds to raise money offshore. About 80% will be invested in the interbank bond market. This will give companies and banks another higher yielding investment.

Challenges remain if renminbi is to become the trading currency of choice but the central bank has responded to hiccups in the trade settlement scheme. Hong Kong banks initially found it difficult to assess whether their clients were trading with eligible counterparties in China and had genuine contracts. Bankers conveyed this to the PBOC and it appointed Chinese banks to check the documents in all situations.

This responsiveness bodes well for the future. The central bank must continue to monitor the success of its trade programme once it goes nationwide and facilitate greater movement of capital across its borders to support its development. Only then can renminbi become a truly global trade currency.
  • 11 Jul 2011

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