Industry March 2011

Rise of the Redback

If there is to be a rival to the US dollar as the dominant global reserve currency in the 21st century, it surely must be the Chinese renminbi. Home to the world’s second-largest economy, China is likely to have the highest gross domestic product by the 2030s. But the currency of the world’s second-biggest exporter has been severely under-represented in international trade and capital markets. As Beijing seeks to rectify the mismatch between the global presence of its economy and that of its currency, the world may be looking at a major financial revolution. Given China’s heightened global influence, the renminbi is an increasingly credible rival and the world economy is, slowly but surely, moving from greenbacks to redbacks.

As a strategic priority, Chinese policymakers will continue to introduce multiple accommodative taxation, trade finance and capital account measures to facilitate the renminbi’s internationalisation process. More importantly, cost savings on foreign exchange transactions and the appreciation of the renminbi should increasingly encourage exporters and importers, in China and abroad, to switch to the renminbi at the dollar’s expense.

Sniffing the potential for business, banks—especially multinationals—have also been eager to get involved in renminbi cross-border trade; their early participation effectively helped launch a global clearing system for the renminbi in just months. Supported at the highest political levels, this catalytic mix of drivers means the acceleration and contours of renminbi internationalisation will be faster and more varied than many may have expected.

Demand for the renminbi as a trade-settlement currency lies in emerging, not developed, economies. Emerging markets now account for nearly 55% of China’s trade, compared with 47% 10 years ago. As the centre of global economic gravity shifts further towards emerging countries, I anticipate an increasingly rapid rise of this share. Since most emerging nations’ trade is invoiced in neither the renminbi nor those nations’ currencies, a switch from the dollar to the renminbi for trade settlement is likely to be an appealing option for emerging nations eager to bolster their relations with China.

The renminbi trade-settlement scheme is triggering a chain reaction in China’s capital markets. Rising demand for the renminbi overseas is smoothing the path for Chinese corporations to invest abroad with the renminbi. As renminbi trade revenue accumulates outside China so, too, will the path be smoothed for foreign firms wishing to invest in China with the renminbi.

Chinese and foreign institutions have recently issued benchmark renminbi-denominated bonds in Hong Kong, ranging from McDonald’s to the China Development Bank and the Asian Development Bank. Recent steps towards easing restrictions on offshore renminbi use have also created the first offshore renminbi interbank market and deliverable spot trading of the currency in Hong Kong.

The pool of offshore renminbi cash deposits has seen an impressive upsurge. Combined with the gradual opening of onshore renminbi capital markets to selected foreign institutions, for years to come this offshore build-up will help widen and lengthen the runway for more renminbi product launches in Hong Kong, which will be best positioned to benefit as the top offshore centre for the renminbi.

These developments are firing up the rapid expansion of the renminbi’s role in trade and investment flows, upping its attractiveness to reserve managers. A few central banks have already expressed an interest in holding renminbi assets as part of their foreign-exchange reserves. However, China is not likely to free up the renminbi to full convertibility until it has put its internal financial house in order. Given China’s economic and trade power, as the country moves closer to the currency’s full convertibility, it will be increasingly natural for the renminbi to become a reserve currency.

Why is this important?

  • Chinese exporters and importers will be more competitive as costs and exchange-rate risks decline, making China’s export recovery quicker and stronger than that of many other countries.
  • The growth of China’s dollar reserves should decelerate.
  • China’s dollar accumulation should slow markedly, as initiatives allow foreign firms to issue renminbi bonds and IPOs.
  • Investment opportunities will increase as policy favours a steady appreciation of the renminbi.
  • Foreign exchange hedging for corporates will grow globally as renminbi cross-border trade