China’s State Council or Cabinet’s decision to permit the use of Ren-Min-Bi (RMB) , in cross-border trade settlement, as part of its long-term plan to globalize its currency and reduce the domination of the US dollar, will eventually reshape forces at play in international foreign exchange (forex) markets.
Presently, the currency of China — the world’s third largest economy and trading nation — is not exerting befitting influence in the forex markets due mainly to limited use of the Yuan in international trade and investments, as well as restrictions placed on its supply and convertibility.
However, the window to Yuan’s liberation was opened wider when Beijing launched the pilot scheme on RMB cross border trade settlement on July 6.
But at this experimental stage, the scheme only applies to dealings with 450 designated Chinese enterprises in five cities — Shanghai, Shenzhen, Guangzhou, Dongguan and Zhuhai. Outside the mainland, it is open only to 10 Asean nations, Hong Kong and Macau. The scheme is expected to cover more areas and countries when it wins widespread appeal.
“The new service is bound to help warm up international trade, further push the Yuan around the globe and alleviate the world’s over reliance on the U.S. dollar,” commented China’s official Xinhua News Agency on July 6 when hailing over the launch of this pilot programme.
The Hong Kong Monetary Authority sees this move as “marking another milestone for RMB business and a move of strategic importance for China”.
Xiahua emphasized that the RMB cross-border settlement is the consequential development of China’s rapid economic growth.
China’s economy, which has undergone rapid development since 1979, is predicted to grow 8.5% this year and to lead Asia’s economic recovery, the International Monetary Fund (IMF) said in early October. It sees growth in 2016k 9.0%.
For the business community, the most obvious good of this scheme is that the RMB trade settlement will offer stability in forex rates. After July 6, importers and exporters of Chinese goods may choose to use RMB, instead of US dollar, in trade settlement.
In the immediate term, the programme helps to mitigate exchange risk and reduce transaction costs for enterprises trading with China, according to bankers. In the longer term, it is expected to boost regional trade. And in turn, businessmen will enjoy higher volume of business.
Apart from businessmen, Chinese banks and foreign banks which are quick to grab opportunities are expected to be beneficiaries of this scheme too.
On the day the pilot programme was launched, The Bank of China — China’s largest foreign exchange bank, transacted the country’s first cross-border Yuan trade settlement deal, according to Xinhua News Agency.
And on the same day, HSBC Bank (Hong Kong) announced it became the first foreign bank to carry out the first RMB cross border trade settlement, in partnership with its strategic partner Bank of Communications (BOC). In August, HSBC Bank Malaysia completed Malaysia’s first RMB-denominated trade settlement in cooperation with BOC.
Indeed, HSBC (China) has projected the demand for trade settlement in RMB to reach US$2 trillion in 2012, accounting for 40-50% of China’s foreign trade. Ben Shenglin, who heads commercial banking of HSBC Bank (China), said at a forum on Aug 13 in Kuala Lumpur: “If 40-50% of the settlement volume is converted to RMB, there will be more diverse options in terms of trade, costs of trade and trade finance, which will reduce foreign exchange risks and transaction costs. It will effectively promote regional trade.”
Although there has been a lot of excitement about the implementation of this programme, trade transactions using RMB have been slow.
According to the Canton Branch of the People’s Bank of China (central bank), only 87 trade transactions using RMB settlement had been completed from July HSBC (China) has projected the demand for trade settlement in RMB to reach US$2 trillion in 2012 to early September. The total value of these amounted to RMB49.9 million.
China’s newspapers, in its interviews with businessmen in Hong Kong, cited the much lower dollar interest rate as one of the main pulls away from using RMB.
As the dollar interest rate is much lower than the Yuan rate — with a disparity of more than 2% in September, businessmen said it is more cost-efficient to use the dollar for trade settlement now. But they added that if the dollar rate rises and reverts back to early 2008 levels, they might opt for RMB trade settlement.
In addition, due to limited access to RMB outside China, overseas importers are reluctant to use their RMB reserves for trade settlement.
The limited number of designated Chinese enterprises and regions permitted to perform RMB settlement, as well as restrictions placed on RMB forward contracts, are also discouraging factors.
In Malaysia, forex trend is the main consideration. Datuk Bong Hon Liong, Deputy President of the Malaysia-China Chamber of Commerce, said in an interview: “Although the chamber welcomes the new initiative, current conditions are not conducive for RMB settlement. With the Yuan trending upwards and the dollar weakening, there is no incentive for importers to use RMB settlement. As for exporters, they are very comfortable with the present rates and old system.”
But Sam Swee Low, an established importer of Chinese machinery, said: “This programme will take time to sink in and improve on. In the long run, when the stabilizing effect of the RMB settlement out-weighs all other factors, businessmen will have to turn to the RMB settlement scheme.”
Indeed, acknowledging weaknesses in implementation, China is taking steps to improve the mechanism and procedure linked to RMB trade settlement.
The Chinese government is considering extending this trial program to the north eastern region and to countries with which China has inked currency swap agreements, according to news reports from China.
The Chinese authorities are also taking Beijing does not need to raise money abroad since it has US$2 trillion in reserves steps to simplify the procedures in dishing out tax rebates to Chinese exporters under this scheme. Importers also enjoy the benefit of this rebate as exporters do factor this into the pricing of goods.
Undoubtedly, the RMB trade settlement will move China closer to having a fully convertible currency and nearer to its dream of globalizing the Yuan.
However, since 70-80% of cross border transactions are conducted in the dollar, the pre-eminence of the dollar in international trade could not be displaced easily. For now, it may be realistic to see the Yuan becoming a regional currency.
It is obvious the Yuan still has a long way to march to attain global status, as it lacks full and free convertibility. It is convertible for trade transactions and foreign direct investments, but not for purposes that encourage speculations. To gain international stature, a currency must be liquid and enjoy demand and acceptance from traders, investors and central bankers. For this to materialize, China will have to reform its Yuan monetary system further.
But China’s other efforts in recent months to globalize RMB have not escaped the keen eyes of China watchers.
Since last December, China’s central bank has signed with six countries — including Malaysia — currency swap agreements of enormous value.
On Sept 2, the IMF announced that China had agreed to use RMB to purchase US$50 billion bonds issued by the IMF. Hence, when the IMF lends to member countries it will either provide loans in RMB or, if in dollars, use its Yuan to exchange dollars with China.
China’s sale of its first Yuan-denominated sovereign bonds on Sept 28 in Hong Kong to foreigners also caused ripples in the Western world. “Beijing does not need to raise money abroad since it has US$2 trillion in reserves. The sole purpose is to pave way for the emergence of the Yuan as a full-fledged global currency,” said a commentary in The Telegraph of Britain.
From these recent moves, it will not be far-fetched to project that China will continue to launch more initiatives to widen the Yuan’s appeal, exposure and marketability.
Like it or not, China is now a major powerhouse and economic force to reckon with. Its desire to play a greater international role can’t be underestimated. If forex experts think that the Yuan will take 15-20 years to join the elite league of global currencies, they may need to take a closer look at the crouching dragon.