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Asia-PacificOctober 1 2015

Has the renminbi's internationalisation rise been thrown off course?

The renminbi is now the world's fifth most popular international payment currency, and has the fourth placed Japanese yen in its sights. Financial policy reform and the introduction of new clearing centres have been crucial to this rise, but will the troubles the Chinese economy has experienced in the past few months derail its progress?
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Only four years ago, the renminbi ranked 35th in the league table for international payments currencies. In 2015, it sits in fifth place. The ascent has been phenomenal.

China’s relaxation of cross-border flow policies and the People’s Bank of China’s appointment of international renminbi clearing centres over the past decade have been crucial to this rise. But more needs to be done at institutional and regulatory level to achieve renminbi internationalisation, and hence full convertibility of the currency and seamless usage worldwide. And events in the past few months – mainland China’s stock market crash and the downward revision of the renminbi – have raised more questions still, say analysts.

Steady growth

In terms of payments, renminbi usage has skyrocketed in the past five years. With a record high share of 2.34% as of July 2015, according to Swift, it ranks above currencies including the Canadian, Hong Kong and Australian dollars. “It really is an achievement,” says Astrid Thorsen, head of business intelligence solutions at Swift. “I expect it might even overtake the Japanese yen, in fourth place, in the coming months.”

The activity for the top three global payments currencies – the US dollar, the euro and the UK pound – is three times that of the renminbi. “Overtaking them will not happen overnight,” says Ms Thorsen.

But progress in regulation liberalisation has been promising. “Many regulatory restrictions have been dropped, so doing business with China using the renminbi is really at corporates’ discretion,” says Frankie Au, head of renminbi products, transaction banking, at Standard Chartered.

As of February 2014, corporates have been able to integrate the Chinese yuan in their global liquidity pools whether their subsidiaries are inside or outside China. This allows corporate treasurers to recycle liquidity within the company more effectively, says Mr Au.

Companies in the Shanghai Free-Trade Zone, which the Chinese government is using as a proxy for financial sector liberalisation, can use the cross-border cash pool liquidity centralisation to move liquidity in and out of China without quotas.

Follow the supply chain

Some analysts argue that at this stage of reform and with many counterparties based in the mainland, it is nonsensical, if not detrimental, for companies trading with China to not settle trade in renminbi.

“[Companies’ counterparties] will encounter foreign exchange costs if trade is not done in renminbi. This will then be added to the price of goods, which will damage corporates,” says Mr Au. “The renminbi is embedded in the supply chain. Corporates would do well to re-denominate trade in renminbi in the long run.”

This will be even more palatable now that companies can access onshore and offshore markets to optimise the foreign exchange rate and to hedge the yuan used in trading with China, he adds. One-quarter of trade with China in the past five years was carried out in yuan.

Clearing centres

Many market participants agree that the establishment of renminbi clearing centres across the world has been crucial to increasing renminbi usage internationally. There are now 15 clearing hubs worldwide. Hong Kong and Singapore remain the respective entry points to the Chinese market and the Association of South-east Asian Nations, but other jurisdictions are gaining importance.

Notably, renminbi cross-border payments between July 2014 and July 2015 increased by 173% in South Korea and by 45% in Taiwan, according to Swift. As a result, the share of renminbi usage by these two countries for payments with China and Hong Kong increased to 84% and 80%, respectively.

“South Korea is very close to China and has many links with it but had not seen strong renminbi usage historically,” says Ms Thorsen. “The People’s Bank of China appointed a clearing centre in South Korea in July 2014, and since then we have seen a very big increase.” In Taiwan’s case, mainland China is its largest trading partner.

As many multinational corporations with Chinese trade relations set up offices in Kuala Lumpur or Penang, Ms Thorsen believes Malaysia could be the next big renminbi hub.

The most glaring absentee among renminbi hubs is the US, which still does not have a clearing centre. “The US has been the most underwhelming. Due to the size of its relationship with China and commercial payments between the two countries, I think the renminbi is still under-used,” says one market participant.

SDR status

The renminbi’s inclusion in the International Monetary Fund’s (IMF's) special drawing rights (SDR) value basket might stimulate more usage. The basket is a synthetic reserve asset calculated by summing the values in US dollars of the SDR currencies (US dollars, Japanese yen, euro and UK pound) daily. Currencies in the basket are deemed safe, liberalised and truly global currencies.

The IMF revision of the SDR basket – including the potential inclusion of the yuan – was due before the end of 2015. But in August, the IMF announced it had postponed the decision until September 30, 2016, to facilitate SDR-related operations, to respond to SDR users’ desire to avoid changes this year and to give users time to adjust to a potential currency addition.

Some market participants think the IMF simply did not feel the yuan met SDR standards. However, Mr Au remains positive. “We think there is a high chance the renminbi will be included. All of the recent liberalising reforms show that China is preparing to allow a lot more cross-border flow,” he says.

If the renminbi is included in the SDR basket, central banks will automatically have portions of the currency in their assets. “This will signal to the market that people should feel comfortable holding renminbi. We will see investors and funds starting to consider diversifying their pools into renminbi assets,” says Mr Au.

Ms Thorsen believes this inclusion would be a game changer for investment flows and for securing reserves in Chinese yuan. “I think it would be a plus, and corporates and banks would be reassured about having a renminbi strategy and would believe investing in renminbi is the right thing to do,” she adds.

Hot Chinese summer

But the stock market crash in mainland China and the downward revision of its currency spooked international investors in mid-2015. Could these events slow down the renminbi’s internationalisation?

After a mid-June peak, China’s onshore stock market lost more than one-third of its value in just a month. Thanks to the state’s drastic intervention thereafter, including the suspension of approved initial public offerings, freezing new share offers and making it illegal for large investors to dump shares over the next six months, foreign buyers will find it hard to forget this crash.

A month later, the Chinese government devalued the renminbi in what was a second shock for the market. The renminbi is not a freely floating currency. China sets the value of the yuan against the US dollar. The currency is allowed to move 2% above or below that value, which is called the daily fixing. But in August 2015, the People’s Bank of China announced the fixing will be based on how the renminbi closes in the previous trading session. As a result, the yuan’s fixing weakened by 1.9% overnight following the announcement. This sent shocks across the foreign exchange markets, and the Chinese government reportedly used up $94bn of its foreign exchange reserves to keep the renminbi stable.

“At this time it is difficult to ascertain the impact the devaluation has had on the renminbi usage for payments with China and Hong Kong,” says Michael Moon, Swift’s Asia-Pacific head of payments.

Though it is hard to identify potential consequences, the devaluation will not have devastating effects, according to Ms Thorsen. “My feeling is that in commercial payments it is business as usual. Normal orders would have gone through in August,” she says. “We will maybe see effects in the coming two to three months where trust may drop and other currencies may be used again [instead of the yuan]. Corporates, however, do not change their invoicing agreements as quickly as market conditions change.”

Currency and equity market shocks aside, the path to renminbi internationalisation has yet to be completed at institutional level. If an internationalised currency is defined as one that is freely exchangeable, tradable and is used for payment flows with no legs in China or Hong Kong, the yuan still does not measure up. “If the renminbi wants to compete with the US dollar, the euro and sterling, it needs to achieve this status,” says Ms Thorsen. Making renminbi trade settlement seamless, error-free and cost-free is also crucial. Only then will the currency be primed for global status.

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