Market is bullish on renminbi internationalization amid China wobbles

Simon Watkins
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Concrete advances towards the full tradability of the Chinese currency are at last seemingly being made, helping to rebalance the country’s growth model but heaping on short-term risks to China’s economic and financial stability.

Talk of when the renminbi will occupy a status on the global foreign-exchange markets on a par with the dominant economic position of China has permeated the world’s financial markets for decades.

Concomitant with this has been speculation about how the imperfect proxies of the onshore traded yuan (CNY) – the CNH in Hong Kong and the CNT in Taiwan (see chart 1) – will also fare.

There is a divergence of opinion on the broad economic trajectory of China, which has negatively fed through to many other Asian assets in general and on the timing of any loosening of the renminbi’s trading policy in particular. 

Road to RMB internationalization

On the one hand, Michael Spencer, Deutsche Bank’s head of Asia Pacific research in Hong Kong, predicts China’s growth will surprise markedly to the upside this year and next, expanding by 8.6% for 2014 and 8.2% for 2015.

"China’s export growth has followed growth in the US and EU economies very closely since 2008 and as those economies recovered in the second half of last year, so did Chinese exports," he says.

"In fact, we estimate export growth has averaged 20% quarter-on-quarter Saar over the past six months, and sustained growth in the US and EU will take export growth in year-on-year terms much higher than we think most investors expect."

On the other hand, many believe that in continuing to shift the country’s principal growth engine from a manufacturing base to a consumer one, the period of rebalancing will see growth, at the most, remain at current levels, if not much worse.

"The stress in China’s economy may worsen in H1 [of this year], particularly in the financial sector, so we expect the monetary tightening bias to remain, at least in Q1, to contain these risks," says Zhiwei Zhang, chief China economist for Nomura, in Hong Kong.

"The PBoC [People’s Bank of China] launched measures to calm rising repo rates and meet liquidity demand early this week, but we take this as a way to contain financial risks rather than a sign of policy loosening, and if monetary policies remain tight, interest rates will likely remain high in H1 and pressure highly leveraged companies and shadow banking institutions."

As such, the bank maintains its view of a one-in-three likelihood of a hard economic landing – defined as an abrupt slowdown in real GDP growth to an average of 5% year-on-year or less over four consecutive quarters – commencing before end-2015.

Since banking sector and capital-account liberalization – which would expose indebted corporates to bankruptcy risks given rising interest rates and FX volatility – is a pre-requisite for meaningful currency reforms, Beijing is unlikely to make meaningful efforts to internationalize its currency, say China bears, adding the short-term need to maintain stability has increased amid headwinds to growth.

However, Patrick Zweifel, chief economist for Pictet Asset Management, in Geneva, tells Euromoney, both as a medium of exchange and unit of account, the yuan is on course to acquire international status in three years, and, within 10 it might unseat the dollar as the world’s reserve currency.

Indeed, if the main consideration for a substantial upgrading of the CNY’s FX status was its use in global trade alone, then it would already be an international reserve currency, alongside the US dollar and the euro.

According to Swift, the yuan replaced the euro in October as the second-most heavily used currency in international trade finance, after the US dollar. The renminbi was used in just under 9% of such transactions at that time, up from just under 2% at the beginning of 2012.

In this context, as long ago as the G20 summit in London in April 2009, Zhou Xiaochuan, governor of the PBoC in Beijing, flagged the notion that the Chinese wanted a new global reserve currency to replace the US dollar.

Initially, it was thought that Zhou simply wanted to expand the use of special drawing rights (SDRs), delineated as they are as a 95% mix of the four key currencies of USD, EUR, GBP and JPY.

However, in later conversations, it appeared the Chinese government thought that incorporating an element of the RMB into the mix, and using the newly redrawn SDR – including the RMB constituent – would be a justified way of proceeding.

The basic economic case for an upwards re-rating of the yuan over time is lent further weight by the latest estimates from the IMF that by 2030 the USD-valued economy of China will have overtaken that of the US for the number-one spot, and that by 2050 the Asian Tiger will have almost double the GDP of the US.

To tweak an old adage, it is not just the size of an economy that counts, it is what you do with it that counts, and if you cannot trade it freely, a currency is not moving anywhere.