The internationalization of the renminbi will be the biggest challenge and opportunity for Beijing’s new leaders – one that will reshape global trade, balance-of-payments trends and financial markets.
However, China’s attempts at creating a breathing, global currency is the apotheosis of the country’s broader dilemma: how to navigate the short-term political and financial costs of opening up a closed state-led system in an orderly fashion.
Beijing has long harboured ambitions for its currency – the yuan or renminbi (RMB) – to become a universally accepted form of trade settlement rivalling, and even emulating, the US dollar. That would allow China’s leaders better to direct, or shape the rules of, the global trade agenda.
Yet getting to that point is proving a challenge. For one thing, China did not expect to be so far along the road so soon. The Lehman Brothers collapse left the country’s leaders in a position of unexpected power, at least when compared with debt-stricken America and growth-hobbled Europe – while reinforcing the economic allure of currency reform and global demand for the renminbi.
As a result, Chinese leaders decided to speed up their currency plans by a few years, though the pace of liberalization is still too slow for reform aficionados.
In July 2009, barely six months after launching a $600 billion bailout plan to save its own economy, Beijing rolled out a pilot scheme allowing mainland firms to import and export using the yuan. A year later, Hong Kong lenders were granted permits to use local RMB deposits to buy higher-yielding mainland debt, giving banks a reason to hold the currency, by now granted the – still unofficial – title of the CNH.
Since then, at least to the casual observer, the market’s early momentum has slowed. Issuance of dim sum bonds – yuan-denominated debt packaged and sold in Hong Kong – remains rare and small scale.
Bilateral deals to allow CNH spot trading in Brazil, among other developing markets, have, at least for now, come to little. And RMB deposits held in Hong Kong flatlined in 2012 after soaring through mid-2011 – though this was largely part of a global theme as foreign investors deserted emerging-market asset classes.
Yet more is going on there than immediately meets the eye. China’s mandarins love a good pilot scheme. Using a region or city as a test-bed for a product or service allows them to segregate wheat from chaff. If something works, Beijing builds on those foundations. If it doesn’t, Beijing scraps the project or, in the case of the spot-trading programme, sticks a pin in it for later.
Charles Dumas, chief economist at Lombard Street Research in London, describes this as the perfect “suck-it-and-see” approach to building up any financial or economic instrument.
Other pilot schemes abound, if you know where to look, all pointing toward the country’s plans first to create an internationally accepted currency by 2015, then to turn the CNH into a genuine global currency, probably not before 2020, decrees the market consensus.
China is making it easier for offshore RMB to return to the country, and for mainland corporates to settle trades onshore in RMB, rather than the US dollar.
Another interesting scheme, launched in January, allows 15 Hong Kong banks to lend up to Rmb2 billion ($320 million) in offshore RMB to companies based in Qianhai, a small district in southern China that harbours plans of becoming a Hong Kong-style hub for professional services.
Qianhai is special for another reason. Beijing imposes a floor on deposit and lending rates across the mainland. In Qianhai, businesses will be able to borrow at whatever rate the market will accept.
Qinwei Wang, a former policy expert at the People’s Bank of China (PBoC), now working as chief China economist at London-based Capital Economics, highlights these “really positive signs” as key elements in “China’s long-term comprehensive financial reform programme”.
China also knows it has a willing ally: the rest of the world. London, like Hong Kong, is aiming to turn the city intoa vast CNH trading hub, creating a new market with the potential to replicate the Eurodollar market. The PBoC seems set to sign a currency swap line with the Bank of England either this year or next, highlighting the private sector offshore demand for RMB facilities.
And Beijing will likely be helped in other ways. Take the IMF’s decision to review its special drawing rights (SDR) by 2015. This process could see the yuan be added to the SDR basket, alongside euros, sterling, the yen and greenback, boosting the currency’s liquidity and profile.
Many imponderables remain. “It’s too early to think of [the yuan] as a global currency,” let alone a truly international currency, says Allan Zhang, an RMB expert at PwC. “The government is still very cautious about losing control of the market.”
This caution is palpable. Beijing is wary of opening fully the capital account in large part because it fears a re-run of the Asian financial crisis, only this time within Chinese borders. “In the late 1990s, [Asian] currencies were [pegged] to the dollar, yet there were no controls over the capital account, so money was free to flood in and out,” says Capital Economics’ Wang. “That is what China fears.”
Mandarins also dread losing control. China cannot viably create a widely traded global currency without removing controls over deposit and lending rates, or allowing financial institutions to compete freely, based on market conditions. It must also open the capital account to allow money to flow across the country’s borders, freely and in both directions.
This would benefit Chinese and foreign stock markets alike, but it would also reduce sharply Beijing’s ability to control its money and its people.“Once you have got your money out of the country, you can also get your hot little body out as well,” notes Lombard’s Dumas. And given the state of China’s banks – bloated, uncompetitive and dependent on a vast pool of domestic savers – China would also, he adds, “likely have a pretty hefty banking crisis on its hands”.
This is the dilemma Beijing faces. Few doubt that the country will have an international currency for trade and investment purposes in the years ahead. However, to become a truly global, freely available reserve currency for central banks and offshore private sector players, China will need to liberalize interest rates, the exchange rate regime and its capital account – flying in the face of its top-down system of economic management.
Perhaps the yuan, incorporating a conjoined onshore RMB and offshore CNH, can even come to supplant the greenback. However, first, China’s leaders will have to ease up a little and offer their citizens the sort of financial freedom enjoyed in the western world.
In a country obsessed, even driven by, the need for control at all costs, there can be no bigger existential test.
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