Yuan on the move

IMF backs progress in RMB internationalization by including it in reserve currencies basket

The renminbi reached a new milestone in its journey to becoming a global currency on Nov 30 when it was included in the International Monetary Fund's reserve currencies basket.

Economists say the decision, although initially symbolic, will have long-term global implications as China continues to ease controls on its currency and capital markets to meet its new responsibilities.

People look at the exchange rate at a moneychanger displaying US dollar, Chinese yuan and Malaysia ringgit bills in Singapore on Aug 24. The renminbi was included in the International Monetary Fund's reserve currencies basket on Nov 30. Photos provided to China Daily

The IMF decision "is a symbol of where the currency is already at and will give a push to where the currency will be used in terms of trade and central bank reserves", says Mark Boleat, policy chairman for City of London Corp.

"It's like an athlete winning a medal," adds Duncan Innes-Ker, regional editor for Asia at The Economist Intelligence Unit. "The winning of the medal is a symbolic event, but the benefits for the athlete's performance and body come from the hard work done in the run-up to that achievement."

The IMF created its basket of special drawing rights, supplementary foreign exchange reserve assets, in 1969. The assets can be exchanged among members for freely usable currencies in times of need. The fund's executive board reviews which currencies to include every five years.

From Oct 1, the renminbi - also commonly referred to as the yuan - will become the fifth currency in the basket, joining the dollar, euro, yen and sterling.

Christine Lagarde, the IMF managing director, has described the Nov 30 decision as an "important milestone" in the integration of the Chinese economy into the global financial system, and "recognition of the progress Chinese authorities have made in reforming monetary and financial systems".

In the basket, the renminbi will have a weighting of 10.92 percent, while the dollar will have 41.73 percent, the euro 30.93 percent, the yen 8.33 percent, and the sterling 8.09 percent.

Miranda Carr, senior analyst at Haitong Securities, says the renminbi weighting displays the IMF's faith in the currency. Initially, her team had expected a 5 percent weighting, gradually increasing to 15 percent as China implements necessary reforms.

"The immediate implication would be for global institutions to adjust the weightings of their foreign currency holdings, including sovereign wealth funds," she says. "In particular, countries that export energy to China such as Russia and the Middle East will adjust their renminbi reserve holdings to support the private sector, as the new weighting will be a better reflection of their trade relations with China."

She expects to see China further ease controls on its bond market and stock market, opening them up more to foreign players, as well as allowing more Chinese to invest abroad.

Foreigners can currently access China's markets only if they are a qualified foreign institutional investor or renminbi qualified foreign institutional investor, or if they buy through the Shanghai-Hong Kong stock connect. Carr says QFII and RQFII quotas should be increased to allow more access, while extending the stock connect to Shenzhen next year should help reduce China's market controls.

European companies will be encouraged by the IMF decision, according Alain Le Couedic, partner and vice-president of Roland Berger Strategy Consultants Greater China. "It shows companies that more reforms are to come, which is a positive signal. European companies hope China will continue to open up its currency while maintaining the currency's stability."

Andrew Malcolm, head of Asian capital markets for British law firm Linklaters, predicts that the gradual accumulation of assets globally will lead to greater issuance of yuan-denominated bonds, particularly sovereign and quasi-sovereign bonds. This, in turn, will encourage more overseas issuance of renminbi bonds, while yuan-denominated assets would become more available overseas, he says.

This year, the People's Bank of China, the central bank, issued its first offshore renminbi bond in London, a major step in the currency's internationalization.

Malcolm says the depreciation of the yuan was a demonstration of greater flexibility, as the new exchange rate was determined in response to market forces.

In August, the yuan depreciated by about 3 percent against US dollar.

Because the CNY (onshore) exchange rate is more controlled than the CNH (offshore) rate, the central bank made a change to the CNH rate as a guide to bring the CNY rate more in line with the true market-driven rate, Malcolm says.

"The adjustment was also a demonstration for the IMF to see China has a more open structure in reacting to market forces. The SDR inclusion will be expected to lead to a closer alignment between the onshore and offshore renminbi exchange rates."

The decision to include the renminbi was made with three main points in mind, he says. The first was quantitative, how much of it changes hands internationally; the second was to what extent the currency is freely usable; and the third was the operational practicality of using the currency overseas.

According to research by Linklaters, China's currency has already achieved some measure of convertibility in 37 of the 40 capital account items on the IMF list, although in most cases subject to continuing quotas, qualifications and registration requirements. Although the renminbi is not "freely convertible" in the Western sense, it should be remembered that China's goal for now is "managed convertibility", Malcolm adds.

Past to present

Historically, the renminbi was pegged to the dollar to help Chinese exporters gain an advantage. Yet since joining the World Trade Organization, China has gradually eased its currency controls to create a level playing field with trading nations.

In 2005, the currency was unpegged from the dollar. Since then, China has kept the renminbi on a managed float against a basket of currencies, which is much closer to a free exchange rate.

The big moment came in 2008, when, after the financial crisis, the United States exercised quantitative easing to boost its economy, which saw China's dollar-denominated foreign reserves plummet in value. The Chinese government realized that, to keep history from repeating, the global economy should not rely on the dollar as the main reserve currency, and it resolved to one day make the renminbi a global reserve currency.

During a G20 summit in late 2008, Hu Jintao, then Chinese president, called for "a new international financial order that is fair, just, inclusive and orderly". Shortly after, Beijing began to encourage the use of its currency in international trade, bank deposits and bond issuances in Hong Kong, and swap arrangements among central banks, which means they hold each other's currency in case of an urgent need for liquidity in the market.

Trade in offshore renminbi has since boomed. An increase in Chinese exports has also led to a surge in demand for the renminbi outside China, as more exporters expect to be paid in their own currency to eliminate exchange risks.

Evan Goldstein, head of global renminbi solutions for Deutsche Bank, says the currency's internationalization in recent years has been characterized by the increasing use of the renminbi in cross-border trade as well as various efforts to liberalize capital accounts.

These efforts have been accompanied by new infrastructure designed to facilitate cross-border trade and investment flows, he says, such as the creation of swap arrangements and the approval of renminbi clearing banks in international jurisdiction by the People's Bank of China.

In Europe, the PBOC has established bilateral swap arrangements with the Bank of England and the European Central Bank. The central bank has also appointed renminbi clearing banks in European financial centers including London, Luxembourg, Paris and Frankfurt, which will work directly with the PBOC to clear and settle yuan-denominated transactions.

Having this infrastructure has led to an increase in renminbi investment opportunities across European financial centers, especially as problems in the eurozone have resulted in investors looking elsewhere for opportunities with higher yields.

For example, investment funds based in Luxembourg have benefited hugely from China's QFII and RQFII programs, according to Nicolas Mackel, chief executive of Luxembourg for Finance, which helps develop the nation's financial services industry.

"The internationalization of the renminbi is a perfect fit for Luxembourg's cross-border expertise," he says. "It's allowed us to further diversify the activities of the financial center and develop new areas of expertise. Renminbi investment products, whether funds or dim sum bonds, have become an important activity of the Luxembourg financial center."

Such initiatives have accelerated offshore use of the renminbi. Globally, renminbi usage in international trade finance grew to 8.66 percent in October 2013, up from just 1.89 percent in January 2012, according to the Society for Worldwide Interbank Financial Telecommunication. This meant the Chinese currency was the second most-used currency for trade finance internationally, just behind the dollar, which accounted for 81.08 percent in 2013.

Many market players have felt the increase in renminbi usage. Wang Huabin, deputy general manager at Bank of China's London branch, says many of the bank's local clients are increasingly using the currency, especially companies with close links with China, including those with significant investments and operations in China or revenue from China.

One such client is British Airways, which has four direct flights daily between the UK and China. Earlier this year the company borrowed in renminbi from the Bank of China London branch to finance aircraft purchases and then used the renminbi revenue collected from its revenue in China to repay the borrowed funds.

In addition, the international community sees the greater flexibility in the renminbi exchange rate as positive progress in its internationalization.

In August, the currency experienced a depreciation of almost 3 percent as the PBOC realigned the CNY rate more closely with the CNH rate, which is more determined by market forces.

Ravi Pandit, executive director of foreign exchange and interest rate products for the Asia-Pacific at derivatives marketplace CME Group, says the central bank's gradual shift to allow the market to determine the fair value of the yuan would lead to greater two-way volatility.

Although this means more currency hedging requirements for companies, he says it will lead to currency trading opportunities. This year, CME Group signed an agreement with China Construction Bank to enable the physical delivery of offshore renminbi futures contracts outside China for the first time.

Experts say this will enable European traders in renminbi futures contracts to settle trade in Europe, a big step for the currency's internationalization. Previously, such futures contracts were settled mainly in Hong Kong, meaning European traders had to have a bank account there.

Where to next?

The SDR inclusion is not the end of the road for the renminbi's internationalization, of course, as eventually China will need to converge its onshore and offshore markets to aid the flow of funds in and out of the country.

To facilitate this convergence, Goldstein at Deutsche Bank says it is important to build up offshore renminbi liquidity and develop more renminbi hedging products, such as foreign exchange futures, interest rate contracts and cross-currency swaps, as well as develop a more active onshore hedging market.

"There needs to be more offshore liquidity so that banks and corporations can be more comfortable with lending in renminbi and raising debt in renminbi," he says.

Internationalizing the renminbi will have several implications for the global financial market, he explains. "It will create another significant currency for central banks, corporate and financial institutions to consider for portfolio management and general currency holdings outside of dollars and euros."

Linklaters' Malcolm adds that he expects internationalization to lead to more measures to liberalize the capital account over the next few years. However, he points out that the Chinese government made clear in evidence to the IMF this year that it does not wish to allow the currency to become freely convertible just yet.

One example is that the government wants to maintain macro control over the external debt of Chinese entities, which means it could restrict those entities from issuing debt abroad. Another is its intention to maintain control of short-term capital flows, which means the government could restrict investors' ability to transfer funds abroad. Short-term capital flows are typically associated with assets such as property investment, which are relatively volatile and prone to sudden capital inflows and outflows.

With these controls, the renminbi cannot be freely convertible in the same sense as the dollar or the euro.

"The objective of the Chinese government to give the renminbi managed convertibility is in line with the overall macroeconomic direction of China, because the country is making a transition from a state-managed economy to a market economy. So it would be logical for the government to have greater control on the currency," Malcolm says.

Zhou Wa and Ren Qi contributed to this story.

cecily.liu@chinadaily.com.cn

(China Daily European Weekly 12/04/2015 page1)