China's Currency Revolution: What it Means for Corporate Treasurers
Over the past few years, there has been a revolution going on within the world of foreign exchange (FX). China’s currency, the renminbi (RMB), is making huge strides within the global payments market. The UK Treasury’s recent announcement that it wants to make London a leading international hub for trading China’s currency was a big moment for Britain and an indication of where we could be headed as the RMB internationalises.
Treasury officials are confident that the new partnership puts London in a strong position to be a major centre for trading the Chinese currency outside China and Hong Kong, forecasting that trade transactions settled in the Chinese currency will reach around a trillion dollars (£650bn) by 20201. The government’s aim is for London to complement Hong Kong in becoming a major offshore centre for the RMB2. Fundamentally, the liberalisation of the RMB is a progressive move that could cause a shift in power away from the US dollar’s status as the world’s reserve currency.
The potential ramifications of this ‘currency power shift’ should not be understated for UK businesses. For decades, a UK-based corporate treasurer would have had to go through a lengthy process when making an overseas payment into China. First, the treasurer would have needed to convert their sterling into US dollars. Having made this conversion, the US dollars would then have needed to be exchanged for RMB – an inefficient process for corporate treasurers to have to undertake that left them exposed to three different exchange rates, and therefore vulnerable to fluctuating conversion rates over a lengthy period of time.
This meant that treasurers were previously unable to fix costs when making international payments and transactions to and from the world’s second largest economy. Which begs the question: how can a corporate treasurer do his or her job and manage a company’s cash flows in the most efficient and profitable fashion possible if it’s impossible to forecast the cost of a large overseas transaction?
To put it into context, in 2011, the pound-versus-dollar exchange rate varied from a low of US$1.5343 to a high of US$1.6707, an 8.16% fluctuation3. Added to this fluctuation, the US dollar oscillated with the Chinese RMB by 5.12% (CNY6.2950 – CNY6.6350) in the same period4.
Exchange rate instability has always been a major issue for corporate treasurers when making international payments. Indeed, having to deal with unknown and uncontrollable costs can be a frustration for anyone. The good news, however, is that treasurers no longer have to be subject to multiple currency exchanges that can be affected by FX volatility and lead to spiralling costs when trading with China. Over the past few years, the Chinese government has quietly begun deregulating its currency to allow Chinese exporters to send and receive payments in the RMB to and from foreign companies. The policy makers inBeijing, as well as Chinese companies, are increasingly seeing the economic benefit of RMB internationalisation.
As China opens up, foreign companies will gradually look to pay Chinese suppliers in RMB rather than US dollars. The Chinese economy grew at 9.2%5, last year and, although down from the tremendous leap of 10.3% in 2010, the country is continuing to grow at a very healthy rate. China’s story is a stark contrast with the UK’s stuttering 0.9% growth during 20116, and it is therefore no wonder that many UK businesses are keen to capitalise on the ‘eastern promise’ that is China’s economy.
It is helpful to consider the recent history in China to understand the reasons why the payments industry is excited by the liberalisation of the Chinese currency. In July 2009, the RMB Cross-border Settlement Scheme was launched. This scheme expanded the RMB currency to cover cross-border settlements between companies in the 20 provinces of China and the rest of the world. As part of the scheme, the People’s Bank of China (PBOC) and relevant Chinese authorities created a list of eligible enterprises, commonly known as mainland designated enterprises (MDEs), who were able to settle their merchandise exports in RMB. The principal moment of the ‘RMB revolution’ occurred in December 2010, when the list of MDEs was expanded from 365 to 67,3597. This expansion meant that the number of Chinese companies that could now settle merchandise exports in RMB substantially increased. The significance of this legislation is huge – it was a real game-changer for global FX and international payments.
As the RMB becomes more accessible through its increased liberalisation, global businesses will increasingly want to trade with China in its native currency. FX experts are anticipating a trend in global treasurers generally favouring the RMB over the US dollar when making payments in and out of the country. Given China’s robust growth rate, this trend is likely to continue as the western economies recover from the global recession.
A growing number of commentators are seeing the possibility of the RMB becoming a global reserve currency within as little as five to 10 years. In this light, the new partnership with Hong Kong has the potential to make London the western outpost for trading the RMB outside of China. The implication of such an event should not be underestimated; the ability to trade in the RMB will not only help UK-based businesses to capitalise on the large and growing economy, but it is also a step in the right direction in terms of an export-led recovery for Britain. So what we are potentially looking at here is a global currency revolution that will have a profound impact on how the UK conducts international business.
With this in mind, it is therefore important for a corporate treasurer to fully understand exactly how they can make the most of trading with China. In June last year, Travelex Global Business Payments added the Chinese RMB to its Global Clearing Network. As a result, over 15,000 of our 35,000 business customers are now able to send RMB payments into China. The ability to do so offers businesses who take the opportunity a number of benefits.
First, treasurers that opt for direct RMB payments instead of multiple FX transactions will instantly reduce their exposure to multiple currency fluctuations. As a result, these treasurers will notice theimmediate benefit in cost management and efficiency in bypassing the US dollar middleman. Corporate treasurers will no longer have to wait for transactions to be processed in three different currencies, resulting in faster, cheaper and more transparent supply chains.
Second, making direct RMB payments will help UK-based treasurers manage cash payments better by eliminating exposure to volatility in the US dollar. Although the dollar’s global dominance is showing signs of weakening, it is still used as a safe haven by investors, which sends it fluctuating during times of economic uncertainty. As mentioned earlier, 2011 saw an 8% swing in the pound-dollar exchange rate. Such a fluctuation would potentially lead to massive cost implications for treasurers who generally transfer large sums of money.
Last, and perhaps most importantly, corporate treasurers that trade directly in the Chinese RMB are more likely to have improved supplier relationships. The resultant reduction in FX documents and delays in payment will go a long way to improve the professional partnership between the UK-based treasurer and the Chinese supplier. Suppliers may also receive faster tax rebates from the authorities, helping reduce costs in the supply chain while simultaneously protecting profit margins. This currency amelioration, coupled with stronger trade relationships, could potentially lead to further business deals, and even recommendations to further Chinese suppliers. A simple decision by its corporate treasurer to switch to direct RMB payments could give a company a competitive edge in one of the world’s key markets.
It is clear that the RMB revolution of the past few years will change the way we transact international business payments. Certainly, London’s recently-crowned status as an ‘international hub’ of the RMB suggests the Chinese government are becoming more committed to the internationalisation of their currency. Corporate treasurers must be aware of the Chinese RMB’s ability to challenge the US dollar as the world’s dominant reserve currency – a likelihood that is highlighted by the London deal. It has been a long time coming, but China is opening up the RMB to the benefit of those who are willing to act fast in using it.
Top tips for corporate treasurers doing business with China:
2Source: HM Treasury: www.hm-treasury.gov.uk/press_04_12.htm.
3Source: Bloomberg: 29 April 2011, £1 = US$1.6707; 22 September 2011, £1 = US$1.5343.
4Source: Bloomberg: 10 January 2011, $1 = CNY 6.6350; 30 December 2011, $1 = 6.2950.
5Source: China Briefing: http://www.china-briefing.com/news/2012/01/27/chinas-provincial-gdp-figures-in-2011.html.
7Source: CitiGroup: http://www.citigroup.com/transactionservices/home/region/asia/docs/list_chinaenterprise.pdf.