Beijing Continues Inexorable Push for Internationalisation of the Renminbi
Direct Trading Between the Aussie and China’s Renminbi the Latest Landmark in the Redback’s Steady Path To the International Forex Market
In 2012 the renminbi failed to win formal recognition as a reserve currency from the International Monetary Fund (IMF), with the global lender leaving the yuan out of its Currency Composition of Official Foreign- Exchange Reserves (COFER) database. April 2013 has brought the agreement to start direct trading between the Australian dollar and the Chinese renminbi. A major development in relations between China and Australia which according to both officials and economists is set to benefit both countries in the long term and is a boon for Australia’s commodity focused exporters. However, of even more significance, viewed in the wider context it is another landmark in China’s inexorable path towards matching its economic might in the global money markets where it still exerts little influence.
Renminbi or Yuan?
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China’s currency, referred to as both renminbi and yuan, is the legal tender in mainland China. Throughout most of China’s modern history, the renminbi’s value has been pegged to the US dollar. Since 2005, the exchange rate has been allowed to float in a narrow margin, whereas in 2009 Beijing launched a programme allowing companies from mainland China to use the currency in international trade.Why is China’s currency referred to as both yuan and renminbi? The difference between the two has been best clarified in a BBC article. While “renminbi” is the official name of the currency introduced by the Communist People’s Republic of China in 1949 and means literally “the people’s currency”, yuan is the name of the unit of the renminbi, although the term itself is older than “renminbi” and is the Chinese word for dollar. As the BBC noted, an analogy could be made with “pound sterling”, the official name of Britain’s currency, and “pound” – its denomination.
While the renminbi (or yuan) may not have yet gained the international status Beijing seems to be targeting, China’s currency already has a popular nickname – the redback – suggesting potential competition for dominance with the US dollar – the currency of the world’s biggest economy popularly known as the greenback.
Aussie Joins the Renminbi Trading Club
The Australian dollar is the third currency in the world to benefit from direct trading with the yuan, The Times noted in its coverage of the news. The first is – of course – the US dollar, and the second the yen. Japan’s currency joined the renminbi club on June 1, 2012, as part of a broader agreement intended to reinforce financial ties between the world’s second- and third-largest economies.
The agreement was hailed by Australia’s Prime Minister Julia Gillard during a visit to Shanghai as “a huge advantage for Australia, not only for our big businesses but also for our small and medium enterprises that want to do business here”.
Given that China is Australia’s biggest export destination, one of the most notable consequences of the agreement is that it will let Australia’s exporters save on significant foreign currency conversion costs.China absorbs more than 25% of Australia’s exports, mainly raw materials including coal and iron ore. According to official Australian statistics, Australia is the fifth-biggest exporter of goods to China, accounting for nearly five percent of China’s total imports in 2011-2012.
Some analysts do not expect the now direct trading between the two currencies to have a major impact immediately. The Financial Times quoted Credit Agricole (EPA:ACA) strategist Dariusz Kowalczyk as commenting that the bank did not expect a lot of forex trading volumes with most flows still settled in the US dollar. Tony Cripps, chief executive officer of HSBC (LON:HSBA, NYSE:HBC, HKG:0005), the third bank to start direct trading between the yuan and Australia’s dollar, commented that the agreement was a “significant step forward in supporting the growing demand for RMB for payments, settlement and financing globally”. Bloomberg quoted him as also saying that greater renminbi turnover and liquidity would “make exchange-rate transactions for businesses and investors from both countries easier”.
Economic Superpower and Financial Minnow
Besides enhancing trade links with another large economy in the Asia-Pacific region, the agreement brings China closer to elevating the international status of its currency to the status of its giant economy.
The existing discrepancy has prompted Leo Abruzzese, director of global forecasting at Economist Intelligence Unit, to refer to China as a “financial minnow”.
Needless to say, the reasons for the renminbi’s current status lie in Beijing’s own policy toward the currency. Firstly, China is keeping the yuan pegged tightly to the greenback with little room for fluctuation. While the peg to the greenback is seen as a factor that contributed to China’s export growth in the last decade, it is also a financial burden for Chinese companies because it increases their transaction costs. Another factor is Beijing’s control over capital inflows and outflows which is preventing the Chinese currency from becoming a global reserve currency.
Stepping up Efforts
The agreement to start direct trading between the Aussie and the renminbi is yet another of China’s steps on the road to raising the international profile of its currency. Another notable move in that direction is the establishment of renminbi currency hubs.
As Win Thin, head of emerging markets currency strategy at Brown Brothers Harriman & Co, put it in a recent Bloomberg article, Sydney is going to eventually become “an offshore hub” for the Chinese currency as a result of the agreement.
When it comes to trading in renminbi, Hong Kong remains the global hub. There are other candidates for renminbi hub status, one of them being London. The Bank of England and the People’s Bank of China have been reported as planning to sign a three-year renminbi-sterling swap agreement.
China clinched a similar deal with Australia in March 2012, which indicates that an agreement for direct sterling-renminbi trading might not be too far away. Britain’s Chancellor of the Exchequer George Osborne recently said that the agreement would “cement” London as a Western hub for the yuan market.
China’s push to internationalise its currency has already lifted the yuan’s profile. As Bloomberg reported at the end of February, the yuan had overtaken Russia’s rouble as a means of payment in the global payments system, according to statistics provided by financial messaging platform Society for Worldwide Interbank Financial Telecommunication. Data showed that in January the use of renminbi rose 24 percent from December, and 171 percent from a year earlier. In addition, China’s currency accounted for an all-time high of 0.63 percent of global payments, making it the thirteenth most-used currency, whereas the rouble slid to spot number 15.
HSBC currency strategists forecast in December that the Chinese currency would become convertible within five years. “Signs are emerging that Beijing policy makers are going to speed up the opening of the country’s capital account,” the strategists wrote in a note, adding that progress in that direction would be much faster than currently expected.
Beijing’s steps to liberalise its currency regime are seen as having the end game of diminishing the importance of the US dollar. Commenting on the opening of direct trade between the currencies of Australia and China, Credit Agricole’s Kowalczyk noted that it was “another small step in reducing the global role of the US dollar and boosting the role of the renminbi”.
Bloomberg quoted Cliff Tan, East Asian head of global markets research at Bank of Tokyo-Mitsubishi UFJ Ltd, as saying that China’s drive for having direct trade with Australia’s currency was “very much tied up with the desire to have commodity pricing other than the dollar”.
The agreement between Beijing and Tokyo, which established direct trading between the yuan and the yen, included the option of Japan adding renminbi to its foreign-exchange reserves – a provision that raised speculation of diversification away from the greenback, given that Japan’s foreign-exchange reserves are largely held in US dollars.
Beijing’s efforts, however, received a blow at the end of 2012 when the IMF did not single the yuan out for consideration to be included in its COFER database.While the inclusion of a given currency in the IMF’s database with quarterly information on the composition of currency reserves of central banks is perceived by some as a mere technicality, it is also seen as a formal recognition of the importance of that currency. Among the reasons why the IMF did not give the yuan a vote of confidence is perhaps Beijing’s control over capital inflows and outflows, given that central banks need to be able to increase and decrease their currency reserves when needed.
Loosening the Grip
That said, Beijing still has a long way to go to internationalise its currency. Among the steps which China needs to take is are the relaxation of controls and capital inflows and outflows, further commercialising its banks as well as widening the renminbi trading band.
Although some analysts see those steps as contradicting China’s traditional policy approach, the benefits of liberalised currency regime such as higher yuan liquidity and lower transaction costs for Chinese companies, not to mention international recognition, are perhaps well worth the efforts. And while the exact pace of China’s currency liberalisation is still to be determined, there is no doubt that the influence of the redback will continue to grow in the years to come – in parallel with China’s growing economic might.
As the Paris-based Organisation for Economic Co-operation and Development (OECD) said in December, China’s economy will overtake the US by the end of 2016.