Xi Jinping, general secretary of the Chinese government, has identified the One Belt, One Road initiative as a top priority. At the 19th Party Congress in October 2017, he cited it as a new frontier in China’s efforts to further open up its economy.
OBOR is expected to benefit businesses in China and beyond, to the extent that it’s facilitating new commercial transactions, argues Michael Moon, head of payments markets, APAC, SWIFT.
“We can expect that to flow into a number of domains, including increased commercial payment activity and trade financing across the industry,” Moon tells The Global Treasurer.
However, not everyone shares Moon and Jinping’s enthusiasm. There are some concerns that China will be exporting some of its economic problems and will increase the strains on its already stressed financial system at home.
This is partly due to the role the Chinese currency, the renminbi (RMB) will play in the initiative.
Internationalizing the RMB
The boost in Asian trade will bring about increased demand for cross-border payments, which will impact foreign exchange and currency-related risks.
In fact, as a recent Forbes article highlighted, “China wants to pay for all the products it buys in RMB and have the smaller countries make the RMB part of their central bank holdings”.
Less than 2% of payments are transacted in RMB today, according to a recent SWIFT report. The US and China are broadly the same size, but the US dollar has a 40% share of global payments and the RMB takes less than 2% share, Moon explains.
“What’s going on there?” he asks. “If you really want to have RMB adopted as an international currency then you need to have businesses and the financial institutions that are serving those businesses offering RMB services. We’re seeing that increasing.
“We’re seeing corporates, particularly in China, interested in invoicing for their services in RMB and requiring that the buyer of the services is paying them in RMB,” he says.
“We’re seeing corporates, particularly in China, interested in invoicing for their services in RMB and requiring that the buyer of the services is paying them in RMB”
Moon believes that the US dollar and RMB’s share of global payments will converge at some point, supported by the increasing size of the Chinese economy.
Commercial use of RMB is a very important part of China’s economic strategy, says Moon.
China has expanded bilateral local-currency swap programs to 21 countries and now has renminbi settlement banks in eight OBOR countries, according to Standard Chartered.
Usage of RMB trade settlement for cross-border transactions between China and OBOR countries stood at 13.9% in 2016, below the 20% level for China’s global trade, Standard Chartered data shows.
“This implies potential for growth in RMB settlement by improving payment systems, lowering currency swap interest rates, and promoting mixed-currency loans,” said the bank in its recent report.
Sam Xu, head of transaction banking for China, Standard Chartered, says: “You would naturally expect [the number of] cross-border payments being made in RMB to gradually pick up. That is a very real expectation.
“It is quite a natural expectation given that China is the second largest gross domestic product (GDP), the largest export economy, the second largest import economy and the third largest bond market globally,” he told The Global Treasurer.
Xu believes that using the RMB for cross boarder payments may benefit the smaller countries involved in OBOR.
“Most [OBOR] players at this point are engineering, procurement and construction companies (EPCs) who at the same time bring to the table financing and/or investment solutions. It is in these companies’ interest to mitigate FX risks by making the direct investment in RMB. This will effectively help promote RMB as an international currency,” he argues.
However, three types of infrastructure need to exist for this to be sustainable. These are a local foreign exchange (FX) market, an efficient cross-border clearing mechanism and quality assets denominated in RMB.
First, a local FX market needs to exist for RMB’s conversion. This is available in only a handful of markets today but gradually increasing, according to Xu.
CIPS supersedes local clearing houses
Second, a cross-border RMB clearing mechanism needs to be established.
“Countries around the world have the designation of official RMB clearing centers. The largest one for RMB is Hong Kong which today does close to 75% of total RMB offshore transactions. The UK is the second largest after Hong Kong,” Moon tells The Global Treasurer.
Such global clearing centers are designed to provide the environment to facilitate greater usage of RMB offshore, in a bid to internationalize the currency so that it has value and utility outside of its home market.
At the heart of why the US dollar or GBP are utilized so widely for international payments is because they have trust, utility and value outside their home marketplace.
However, Xu argues: “With China’s Interbank Payment System (CIPS) introduced in 2015 and recently upgraded to 24×7, RMB clearing will become more efficient hence making it easier for companies outside of China to switch RMB settlement.”
Rajesh Mehta, Citi’s regional head of treasury and trade solutions, Asia Pacific, describes this as “a very interesting change”.
“For several years China was trying to set up renminbi clearing systems all over the world. In almost every country they’ve wanted to have the renminbi clearing locally. But there’s been a bit of a pivot, if you will.
“I think [the Chinese government] has realised that the best way to clear a currency is to clear it in the mother country, as you do for dollars, sterling or euro. Because that’s where you have the most liquidity and where you get the scale rather than having these little satellite clearing systems for RMB in every country,” he explained.
Making RMB a reserve currency
Third and finally, quality assets denominated in RMB need to exist so that investors choose to hold on to RMB as a reserve currency.
The opening up of China’s Inter-Bank Bond Market (CIBM) two years ago, as a result of RMB becoming the third ranking Special Drawing Rights (SDR) currency by weighting, has attracted many investors, sovereign, public and private.
“Recently announced MSCI inclusion of China’s equity index as well as Bloomberg Barclays Bond Indices inclusion of China’s bond indices will no doubt further promote RMB’s status as a reserve currency,” says Xu.
“The most critical condition to RMB internationalization’s success is to ensure sustainability and consistency of regulations to further the opening up of China’s financial markets,” he argues.
“The most critical condition to RMB internationalization’s success is to ensure sustainability and consistency of regulations to further the opening up of China’s financial markets”
Capacity and scale
As more capital flows come and go into RMB, the currency will gain international scale. Mehta believes that the only way RMB will clear in future will be through the CIPS system, replacing all satellite clearing RMB mechanisms, over time.
At the same time, China is slowly lifting capital and foreign exchange control. This will have to happen if China wants to internationalize the RMB, Mehta argues.
“Once that happens RMB will be ‘internationalized’ and RMB correspondent banking will become a big thing. We’re a few years away from that, but directionally, that’s the way it will go,” comments Mehta.