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The debate rumbles on around when exactly during the 1920s and 1930s the US dollar surpassed sterling as the world’s leading international currency.
Now, though, what is indisputable is that China will surpass the US as the world’s largest economy – possibly by the end of this year – and the renminbi will almost certainly continue its rise and at some point in the next decade will start to directly challenge the US dollar as the leading international currency.
That will be a profound event when it comes, symbolizing and confirming China’s rise as a world economic and political power as much as underlining the fall of the US and the west’s long-held economic supremacy.
The internationalization of the renminbi is essential for this to happen, which is why Beijing has been prudently hastening the currency’s use in recent years through a liberalization programme that Adam Smith would have been proud of.
|World payment currencies vs. trade|
Global share (extra-regional trade only for Europe)
|Source: WTO, Swift, Standard Chartered Research|
China’s new leaders have galvanized this free-market push since taking charge early last year, bringing about capital market and interest rate liberalization and establishing the Shanghai Free Trade Zone in the first few months of office.
Since then, interest rates have been freed up for foreign-currency deposits and within the SFTZ – a testing ground for economic reform – restrictions on cross-border capital flows have been removed. In addition, the daily trading band for the spot rate between the renminbi and the US dollar has been widened from 1% to plus or minus 2% a day, providing greater freedom around market pricing.
Taken together, these reforms highlight China’s commitment to reform and point to capital account liberalization being closer than ever before.
The opening up of the capital account, enabling companies and investors to trade the renminbi across China’s borders without hindrance, is seen as the crucial reform for the currency to emerge as a truly global rival to the US dollar.
“If the authorities can, in time, loosen up the capital account, that would be great for companies,” says Rachel Miao, finance director, China, for Dover Corporation, a US-headquartered manufacturer of specialized industrial products and equipment.
The consensus view is that this will happen by 2020, but it could reasonably be expected to occur in the next two to three years, according to HSBC.
In international payments and trade settlement – a vital artery of the global economy – this reform in particular is seen as one that might help trigger a big-bang moment when companies worldwide truly embrace the renminbi and use it pari-passu with the dollar, euro and sterling to pay for goods and services.
|“China is currently the number-two world economy, it has the seventh-largest traded currency and it is one of the most significant exporters. The only missing piece is capital account reform and full convertibility”|
-Evan Goldstein, Deutsche Bank
Kee Joo Wong, head of global payments and cash management, China, at HSBC, says that should this happen there is a distinct possibility the renminbi will become a top-five world payments currency within five years from now.
The renminbi has a long way to go before it achieves this status, but it has already made dramatic progress in the past three years alone, overtaking 22 other currencies to break into the top-10 most used currencies for payments and trade settlement for the first time this year.
In March, the renminbi was the seventh-most-used currency, with a new record-high share of 1.62%, according to Swift data. Standard Chartered estimates that renminbi trade-settlement volumes could quadruple to $3 trillion by 2020 – making it the fourth-largest payment currency in that time behind the US dollar, euro and sterling.
Capital account reform and full convertibility of the currency is vital for this to happen, but ahead of that time are the world’s largest multinational companies ready to ditch the dollar for the renminbi? And beyond the focus on and excitement around this policy event, what is it actually going to take to make the renminbi a mainstream international payment and trade-settlement currency?
Faith and trust in the authorities has a large part to play in answering that last question. Much of the renminbi’s early momentum, spurred on by Beijing’s reformist zeal since 2009, has come from those multinational companies that buy from and sell to China vast quantities of goods and services, in turn creating a naturally deep demand to do business with the China in its own currency.
But mainstream currencies cannot be perceived to be a one-way bet as the renminbi has been. “When we talk to our clients one of the first questions they always ask is: ‘Is it a one-way bet?’” says Jinny Yan, a senior economist at Standard Chartered. “We have seen some depreciation in the value of the renminbi recently, and that has put the question into people’s minds as to how much they can continue to believe the currency will continue to appreciate.”
HSBC’s Wong argues that Beijing allowing the currency to fluctuate more against the dollar, “is a demonstration to companies and consumers that this currency is being driven by market forces”.
Widening the trading band between the renminbi and dollar to plus or minus 2% a day does not create a freely traded currency, but it’s twice as free as it was.
In addition to this, it’s imperative that Beijing continues to prove that it is willing and able to put in place the reforms needed to support China’s growth and development, and by extension of that the renminbi’s internationalization.
“If the renminbi is to be utilized frequently and by many more corporates, there has to be a certain level of comfort,” says Wong. “Attaining that stems from treasurers understanding the direction in which the authorities are moving.”
|Share of RMB trade settlement to double by 2020|
|Source: Standard Chartered Research|
These elements together are important to encourage confidence and the broader use of the renminbi, but ultimately this will be driven initially by demand among large multinationals that see China as a critical market for them.
Since 2009, when Beijing began to loosen controls on its current account by launching a trade programme enabling companies on the mainland to use renminbi for international trade, some multinationals have jumped on the opportunity to pay their China-based customers and suppliers in renminbi.
Sweden’s Ikea, the world’s largest furniture retailer, and Germany’s Henkel, a consumer and industrial goods manufacturer, were among a small group of multinationals to pioneer this a couple of years ago, in effect having their China subsidiaries invoice cross-border transactions in renminbi rather than in dollars.
|“When we talk to our clients one of the first questions they always ask is: ‘Is it a one-way bet?’ We have seen some depreciation in the value of the renminbi recently, and that has put the question into people’s minds as to how much they can continue to believe the currency will continue to appreciate”|
-Jinny Yan, Standard Chartered
UK supermarket group Tesco and Germany’s Siemens, Europe’s largest engineering company, have most recently followed Ikea’s lead. In February, Siemens announced that it had introduced the renminbi as an additional ‘regular’ currency with the same payment status within the company as other cross-border trade-settlement currencies, and particularly the US dollar and euro.
“Siemens has a broad presence and a long history in China dating back to 1872 when we supplied China with the first pointer telegraphs,” says Bernd Euler, chief financial officer of Siemens China. “To adopt the renminbi invoice procedure with our customers and suppliers is a shift that supports Siemens in gaining a competitive edge in this major market.”
It’s an edge many other multinational companies that trade with and have substantial investments in China are eager to gain too.
According to Standard Chartered’s sixth quarterly Offshore Renminbi Corporate Survey – in which around 130 senior finance managers of companies across Asia, Europe and the US were interviewed – some 48% of those that import from China said they preferred to pay their mainland suppliers in renminbi.
Similarly, 45% of those that export to China preferred to quote prices to their mainland buyers in renminbi. This contrasts with 29% of importers and 18% of exporters who would prefer to do deals in US dollars, according to the survey.
HSBC’s Wong says European multinationals seem to be making the most progress on this front and some companies that he knows have even moved almost 100% of their intercompany transactions into renminbi.
He adds that they are also increasingly comfortable with accepting third-party payments from their suppliers in renminbi, which might be one of the key next phases in driving the use of the currency throughout the corporate spectrum.
“If the renminbi is to be widely used, it has to go far deeper into the supply chain of large companies and that means small and medium-sized enterprises,” says Deborah Mur, head of treasury and trade solutions, western Europe, at Citi.
Penetration among the world’s smaller companies will undoubtedly take a lot longer than for the multinationals, but with the right clearing and settlement infrastructure that evolution could take place a lot more quickly than expected.
Specifically the People’s Bank of China has been developing its own international clearing and settlement system, known as China International Payments System (CIPS), which it expects to launch this year after several delays. The onshore system, China National Payments System, is also being upgraded by the PBOC.
The idea behind CIPS is to have a new renminbi clearing and settlement network that is wholly integrated with the onshore financial system and is scalable enough to handle the surge in international renminbi usage over time.
Once launched, CIPS is expected to be a key source of international renminbi liquidity, says Standard Chartered’s Yan.
For Citi’s Mur, the launch of CIPS might have a more profound impact. “If you’re looking for an ‘a-ha!’ moment,” she says, “I think the launch of the clearing system CIPS will provide that moment. That’s when the user experience should significantly improve.”
There is no question that CIPS has the potential to be a game changer. Although the international renminbi clearing platform hasn’t been launched yet, the basic functionality of it is expected to markedly improve access for foreign corporates as well as help accelerate the process of internationalizing the renminbi.
Indeed, for the first time CIPS will put the renminbi on an even footing with other global currencies in areas such as operating hours, risk reduction and liquidity optimization. This is good news for companies using the currency.
But Rani Gu, transaction services products head for Greater China at JPMorgan, says that for them to get the best out of it most need to enhance their enterprise resource planning systems to use the renminbi efficiently as a functional treasury currency. She says that is happening and in addition “companies that have renminbi payables and receivables are increasingly looking at centralized payment processing and management, which can often mean incorporating the renminbi into a regional treasury or payment factory.”
However, as much as there is excitement behind CIPS, there is caution too. There are questions, for example, around the extent to which CIPS will embrace international standards, its robustness, whether it will run on a gross or net settlement basis, and the definition of its rules around finality and insolvency.
The hope is that CIPS will meet the efficiency of some of the most advanced clearing systems such as the UK’s Clearing House Automated Payment System (Chaps) or the Clearing House Interbank Payments System (Chips) in the US, which combine elements of both netting and real-time gross settlement.
The importance of CIPS, if Beijing gets it right, is not lost on Deutsche’s Goldstein, who says it could create the closest event to a big-bang moment in the renminbi being used as a payments and trade-settlement currency.
“If large corporations start to really reconsider the currency within their SAP and accounting systems, and if market infrastructure initiatives like Sepa [the Single Euro Payments Area] and ISO20022 [global messaging standards] consider the renminbi and the onshore platform develops a PvP [payment versus payment] or RTGS [real-time gross settlement] settlement finality, then you’ll start to see all the pieces move into place for this major event.”
He adds, however, that China still has “different payment standards and formatting migrations (CNAPS to CIPS), and that some form of standardization for cross-border payments would need to happen before this will occur.”
Citi’s Mur shares this view and says that if China’s CIPS is the equivalent to Chips, Chaps and Target 2 – an interbank payment system for the real-time processing of cross-border transfers throughout the European Union – it will certainly help facilitate the broader adoption of the renminbi.
If there is one global industry that could accelerate this and more fundamentally potentially cause a revolution in how the renminbi is used, traded and indeed priced, it is the sector for which China is largely reliant on imports: commodities.
Close to one-third of China’s imports are commodities, and iron ore, coal, crude oil and soya beans together make up almost 20% of that. And if, as Standard Chartered expects, China’s trade invoiced in renminbi could double by 2020 to around 28%, or over $3 trillion, then the invoicing of China’s commodity trade in the currency would go a long way towards accelerating this shift.
Most global commodity trade is currently dollar-denominated, but even a partial redenomination of China’s commodity trade into renminbi would substantially boost renminbi trade flows. Standard Chartered expects renminbi-denominated commodity trade flows to account for about 6% of China’s trade by 2020.
“While Renminbi-invoiced commodity trade will likely grow at a slow pace to start with, the oligopolistic structure of China’s biggest commodity suppliers should cause the growth rate to increase exponentially once renminbi-denominated flows reach a critical size. We expect this to happen in 2019,” says Kelvin Lau, senior economist at Standard Chartered in Hong Kong.
Lau adds that he expects renminbi invoicing to start with small one-off trades in crude-oil and soya-bean imports, and that when renminbi-denominated trade payments become more popular, commodity producers are likely to want further exposure to the currency. This will require pricing commodities directly in renminbi, instead of obtaining the price from dollar-denominated indices.
“While such a redenomination of commodity indices is still some way in the future, we believe the markets will move in this direction,” says Lau.
Deutsche’s Goldstein believes that the markets “would stand up and take notice” if a “major foreign commodities company repriced or started quoting in renminbi”. But he says that even if that did happen it would not necessarily “be a catalyst for widespread change because the US dollar is still the major international currency by a long shot”.
Euromoney contacted oil companies BP, Exxon Mobil, Shell and commodities trading and mining company Glencore Xstrata seeking comment on this, but they either declined to comment or did not return calls.
From the evidence so far, this remains an early stage development, but HSBC’s Wong says that some of the oil majors are raising renminbi funding offshore by issuing dim sum bonds, through bank debt or simple FX swaps, and investing capital back into China via shareholder loans in renminbi, and utilizing the new cross-border lending or sweeping schemes to extract whatever excess liquidity they have in the country. “As such,” says Wong. “You could say they have gotten their feet wet and are moving in this direction.”
Indeed, the day one of the big oil companies first invoices China for oil in renminbi and receives payment in Chinese government bonds as a result will likely be a watershed moment for the renminbi as a world payment and trade-settlement currency.
Citi’s Mur says that in the meantime the planned US IPO of Chinese e-commerce company Alibaba later this year will be an interesting catalyst in the internationalization of the renminbi.
The company, founded in 1999 by former English teacher Jack Ma, controls an estimated 80% of China’s e-commerce market through its Tmall and Taobao sites, with almost $250 billion-worth of goods sold over its Chinese marketplaces last year.
“If their 230 million-plus active customers start buying and selling cross-border and then settling in renminbi,” she says, “that is going to be another phenomenal driver of flows.”