The RMB reaches a crossroad

RMB internationalisation has received a lot of attention, perhaps even 'hype' at times, but in many ways this topic is more about the internationalisation of a country rather than its currency.

"If [China's liberalisation] is not managed in a carefully sequenced way, there could be significant domestic and global consequences."
Daniel Everett, Global Head of RMB, Strategy and Execution | ANZ

One of my favourite quotes from a recent forum was from a speaker who said reform in China and RMB internationalisation presents a situation which “…is astonishingly frightening but at the same time an astonishing opportunity".

He was right.

ANZ attended the third Australia-Hong Kong Renminbi Trade and Investment Dialogue in July. The forum, run by the Hong Kong Monetary Authority, Australian Treasury and the Reserve Bank of Australia, brought together over 160 representatives from the industry to debate key themes around opportunities associated with the RMB's internationalisation.

In addition, we recently brought together over 100 clients at our inaugural FT-ANZ RMB Growth Series conferences in Hong Kong and Sydney following the release of our RMB report “The Renminbi Takes Centre Stage".

The RMB Growth Series events covered a broad range of topics and I found myself madly scribbling down notes to absorb the wealth of new information. Many themes from the Australia-Hong Kong Renminbi Trade and Investment Dialogue emerged in our conferences as well.

THE LIBERALISATION DILEMMA

So why is RMB internationalisation astonishingly frightening but at the same time an astonishing opportunity?

Despite the enormity of the opportunity China's economic size presents in an open market, our speaker reminded us it is normal for a closed financial market, once opened, to suffer a crisis (for example, the US in the 1920s and Japan when it internationalised the yen).

It is clear China faces a challenge, both economic and political. We are seeing that playing out at the moment with equity markets.

Capital account liberalisation is vital for increased global integration and use of the RMB. However, if it is not managed in a carefully sequenced way, there could be significant domestic and global consequences.

Our Sydney panel noted China is wary of developed market models which have broken down on many occasions and continue to do so. The US issues which came to a head in 2008 and the continuing European dramas are prime examples. Why, therefore, should they listen to the rest of the world?

Opening capital flows too fast would bring financial instability while going too slow reduces China's ascension, and that of the RMB, to its targeted place among the dominant financial markets and currencies of the world.

This would be counter to China's desire to internationalise the RMB, ensure greater influence in global capital markets and be less reliant on USD.

Either way, integrating a financial market of this size into the rest of the world is a colossal event.

RMB AS A TRADE FINANCE CURRENCY

Our Hong Kong panellists believed trade continues to be a critical focus in terms of generating offshore flows. While the statistics show almost 25 per cent of China's cross border trade is currently RMB denominated, from a zero base in 2009, the underlying 'true RMB trade' (once arbitrage and re-invoicing out of centres like Hong Kong are excluded) would look much lower.

There is therefore an enormous opportunity still present with China's largest trading partners to increase adoption of RMB in their trade transactions.

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Our Sydney conference noted RMB settled trade between Australia and China was currently less than 1 per cent of the total. This low level is driven by:

• historical $US pricing for Australia's large commodity exports;
• Chinese banks not encouraging Chinese corporates to use RMB as it would reduce their FX revenues; and
• The speculative nature of Chinese corporates in relation to currency movements.
  
  

What could help fuel growth in RMB trade? Firstly, the opening of China's very liquid onshore commodities exchanges to international investors could have a profound impact, providing a starting point for more commodities to be priced and traded in RMB globally.

Additional growth may come from an increasing desire in China to manage currency risk, as one corporate customer in Hong Kong noted.

Matching revenues and expenses in RMB is becoming more important as the currency moves towards a free float. RMB is no longer a “one-way appreciating bet" so a more prudent approach may see less $US financing by onshore corporates and more RMB settled trade in the future.

For Australia, the recently signed China Australia Free Trade Agreement might be a further catalyst for increasing RMB denominated trade between the two countries.

RMB AS AN INVESTMENT CURRENCY

A consensus in both Sydney and Hong Kong was that as liberalisation continues to progress, an enormous opportunity exists for the global investor community in China's onshore capital markets.

RMB internationalisation and capital account liberalisation is central to China's development and as one speaker in Sydney noted “…it will fundamentally change how capital flows around the world….this is massive!" Capital markets, rather than banks, will start to allocate capital.

China's bond market is the third largest in the world at over $US5.3 trillion while its equity market is the second largest in the world at around $US7.9 trillion.

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These markets have been difficult to access for foreign investors who have to navigate a quota based system to invest. Total quotas of approximately RMB2.2 billion have been permitted across three market access programs with around half utilised to date (Figure 3).

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However, these quotas account for just over 2 per cent of the size of the capital market which is very small indeed.

Despite recent market volatility, it is abundantly clear that as quotas are increased (or abolished) in due course, the demand for onshore securities will significantly increase. This demand is even more likely when firms like FTSE and MSCI begin to weight China in their indices.

A final eye opener for me from one of our corporate multi-national clients in Hong Kong was about the benefits they have extracted from reform around RMB cash pooling and invoice netting through their payment centre.

The customer estimated centralised netting across payments and receipts has reduced transaction volumes by 70 per cent to 75 per cent.

Another speaker in Hong Kong recalled a corporate who saved over €300,000 from cash pooling and netting structures and another who saved around 2 per cent in financing costs by using internal pooling to fund subsidiaries rather than external financing.

These examples really highlight the real opportunities emerging through capital account reform and how ANZ and our customers need to be at the forefront of these changes.

In Sydney and in Hong Kong, we also heard from issuers who championed the merits of the offshore RMB bond market to access new investors and diversify funding sources. The need to be opportunistic and be ready to go when pricing was right was a key message.

THE FUTURE

So where to from here for the RMB? It was quite apparent to all at the conferences that ongoing liberalisation efforts will continue to gather pace and new opportunities will, as a result, emerge with increasing regularity.

Banks, corporates and investors must be nimble and think end to end about their businesses and solutions to succeed.

RMB is not a one-size-fits-all proposition; each business will have different needs and challenges. It is, however, almost a one-event-affects-all situation given the importance of China's global linkages.

This importance will only grow and the RMB's transition as a future global currency seems assured. However, reform and progress won't come without some – and maybe considerable - volatility along the way.

Daniel Everett is Global Head of RMB, Strategy and Execution at ANZ.