Renminbi: The ASEAN Paradigm
China has emerged as a manufacturing power and key player in the global economy during the past decade. Both China’s current account and capital account surplus has been ballooning. This is a unique situation that China is in, as it faces huge capital inflows from foreign direct investment (FDI), exports overtaking imports and restricted capital outflows (regulation).
This huge capital inflow and trade surplus is having an inflationary pressure on the local economy and the government is looking at ways to reduce this imbalance of payments by reducing the dependence on US dollar – denominating some of the current trade flows in renminbi (RMB) is a first step, followed by the possibility of deregulation at a later stage.
China’s global trade totalled about US$2.5 trillion in 2008, with approximately US$200bn of these trade flows with Association of Southeast Asian Nations (ASEAN) counterparts. The ASEAN region includes: Indonesia, Malaysia, the Philippines, Singapore, Thailand, Brunei, Burma (Myanmar), Cambodia, Laos, and Vietnam.
Figure 2: China’s Foreign Exchange Reserves 2004-2008
Source: State Administration of Foreign Exchange, PRC
Table 1: Monthly Foreign Exchange Reserves 2009
Source: State Administration of Foreign Exchange, PRC
A few points to consider in light of the above surplus and capital flows:
These reserves are set to further increase as capital inflows and exports grow in future. All this surplus reserves have to be deployed to generate returns. It then is of no surprise to discover that China is one of the biggest buyers of US treasury bills and commercial paper, thereby funding the US trade deficit.
Despite China’s manufacturing prowess, its own currency has been largely restricted to its own shores in terms of demand. Most of China’s international trade with its trading partners is denominated in US dollars. This lack of international demand for the RMB is primarily due to the various capital controls imposed by the Chinese regulators historically
Exporters in China are exposed to the currency risk and albeit currently the RMB is tightly pegged to the US dollar, in future deregulation could expose these entities to the risk of an appreciating RMB.
Given some the implications of the large capital inflows and foreign currency surpluses, the China central bank, Peoples Bank of China (PBOC), took steps to internationalise the RMB. One of the fundamental attributes of an international currency is the ability to be able to finance/settle international trade in that currency. For the Chinese trading houses, being able to invoice in their own currency essentially pushes the foreign exchange (FX) risks associated with the trade to their counterparties in the other markets.
In the light of the above, recently China has been making moves to allow the RMB to be more easily used as a settlement currency for international trade. Currency swap agreements have been put in place between PBOC and the central banks of various trading partner countries, such as Indonesia, Hong Kong, Malaysia, etc, as a foundation to inject domestic RMB liquidity as domestic demand for RMB loans, etc picks up in these markets.
Figure 3: Currency Swap Agreements
Source: Standard Chartered
ASEAN Pilot: RMB Trade-settlement Programme
In Dec 2008, a pilot programme was launched to allow settlement of cross-border trade between mainland China and Hong Kong, Macau, and ASEAN in RMB on a trial basis. The pilot programme is restricted to a select list of approved mainland designated entities (MDE), and allows these selected exporters/importers in five Chinese cities to settle cross-border trade deals in RMB:
It is envisaged that the pilot programme will be expanded in the near future to cover more entities and markets.
The pilot programme aims to:
A few banks in Asia have announced their ability to offer RMB denominated trade loans and settlement services. A few such transactions seem to have been successfully executed based on reports in local media in Singapore, Hong Kong, etc. This is a key and imperative first step in the RMB gaining wider acceptability and demand in its aspiration to be a regional/global reserve currency.
The use of RMB for invoicing purposes will have significant implications for ASEAN corporates. In the pilot phase, the impact is restricted to corporates in ASEAN, Hong Kong and Macau dealing with their counterparties in China; however, these restrictions and regulations could change swiftly when and if China decides to expand the scope beyond ASEAN.
Corporates in ASEAN that are dealing in two-way trade with China will now have an opportunity for natural hedging of their RMB cash flows. However, if only one leg of their trade is with China, there will be no immediate impetus to switch to RMB unless they don’t have much bargaining power with their mainland China suppliers/buyers or, alternatively, the domestic cost of borrowing/investing in RMB in their markets is attractive vis-à-vis the local currency and US dollars.
The current PBOC regulations restrict the use of RMB to trade settlement (with supporting documentary evidence) and related FX (only spot FX), and RMB deposits from trade proceeds. Other benefits could include transparency in procurement costs (price denominated in RMB) and costs reduction on account of tax benefits to MDEs (exporters) in China, which presumably will be passed on by the MDEs to their trade counter-parties.
The challenges ASEAN corporates would face could include:
Given that this initiative is currently in the pilot phase, answers to some of these questions are still being developed. It is envisaged that the list of MDEs will be eventually opened up and so will the capital markets for RMB, allowing corporates better investment options for their RMB funds.
As Chinese enterprises switch their invoicing from US dollars to RMB, banks in ASEAN will have to enable their cash and trade platforms to be ‘RMB ready’. This will involve arranging nostro service agreements with relevant Chinese banks to clear RMB payments to/from China, as well as enabling their banking platforms to handle RMB deposits, RMB payments, RMB trade finance, etc.
In the pilot phase, the PBOC has restricted the use of nostro balances to be used for sole lending to the nostro provider. This could have domestic net capital implications to local banks in ASEAN who are subject to ‘net lending’ caps on their assets and offshore balances.
Domestic RMB liquidity pools currently do not exist in the interbank space in these markets. While currency swap agreements have been put in place with the central banks of a few countries, the PBOC and regulators will need to allow mainland China entities to allow capital investment in RMB offshore, as well as allow eventual full convertibility of the RMB and access to an international capital market (bonds, commercial paper, equities, etc) for foreign institutional investors.
Hopefully some of these regulations are eased as the demand for RMB picks up in ASEAN with its use as the invoicing currency for cross-border trade with China.
While RMB internationalisation, and its use as an invoicing currency for international trade, is a step in the right direction for China, it also has to deregulate the RMB, promote Chinese corporates to venture abroad and invest offshore in the long run. It must establish an onshore RMB capital market, which would offer avenues for investors (onshore/offshore).
The first step in that direction has been to use RMB as a trade settlement currency. Other policy changes will have to follow to allow adoption. With more of its national currency used offshore for investments, as well as invoicing, China stands to gain from addressing its balance of payments situation and its importance in the world financial system.
However, with market determined demand and more use of the RMB offshore, domestic policy will have a lesser impact on RMB rates and flows. This will be the trade-off that regulators will be faced with as they push RMB internationalisation.