The birth of a global currency

In China’s remarkable rise on the global economic stage, one key element of the country’s economy has trailed far behind. The renminbi (RMB) or yuan remains an exotic instrument, rarely used outside the Chinese borders and barely understood.

Photo: Thomas Ruecker

The world’s second-largest economy has a currency that ranks 14^th most used in the world, just ahead of the Danish krone, behind the Russian rouble and miles away from the euro and US dollar, No. 1 and No. 2, respectively.

But that is quickly changing. The internationalization of the RMB, as engineered by the Chinese government, is happening at warp speed. At the start of 2012, the RMB ranked 20^th among international currencies, according to SWIFT (Society for Worldwide Interbank Financial Telecommunication). It leaped six spots in nine months.

“At some point in the next decade to come, the RMB will be a major player among global currencies,” said Chris Davies, Deputy CEO of HSBC China. “This is very much a step-by-step process, a technical process, as the currency moves from being ‘ring-fenced’ to one more convertible globally.”

Mr. Davies was one of several HSBC China experts speaking to business executives in Chicago and Los Angeles about the RMB and strategies for dealing with it. HSBC is the largest foreign-owned bank in China, with 133 branches currently and 15,000 employees in the country encompassing banking business as well as processing centers.

Tellingly, in a poll taken at the Chicago event, 95% of those in attendance said they were already doing business in China, but none said they were using the RMB for trade settlement. Considering that less than a decade ago the RMB was a closed currency, with major barriers to getting it out of the country and no market for it anyway, that is not surprising. Businesses are just catching up to what could arguably be called the birth of a new global currency.

Still, the delivery of the RMB to the world is being carefully driven by China, and is following a clear roadmap. Starting with pilot projects, China’s gradual loosening of controls on the RMB has allowed foreign businesses and investors to get used to the currency, while protecting China’s rapidly growing economy from speculative money flows and other financial risks. Reaching double-digit GDP growth rates over the past decade, the country’s recent slowing to a range of 7%-8% is considered a more stable rate by the Chinese government, which is forecasting that to be the norm for the next decade or two.

Most of the currency reforms to date have been in the area of trade settlement, to establish the RMB as a global trade currency. In July 2009, an RMB trade settlement pilot was launched in five mainland cities, restricted to trade with Hong Kong, Macau and ASEAN. A year later, the pilot area was expanded in China and to all countries worldwide. This past June, all final restrictions were lifted, allowing any Chinese and foreign enterprise to buy or sell goods and services across the border in RMB-denominated funds.

Next up is for China to establish the RMB as a global investment currency, a process that has already begun, but will proceed cautiously.

In 2010, RMB usage was deregulated in Hong Kong, setting up the city as an RMB investment and transaction hub, and one of the deepest pools of RMB liquidity outside mainland China. By some estimates, approximately 30% of Hong Kong’s total deposits will be in the yuan in the next couple of years. Indeed, some other financial centers, including London and Singapore, are also vying to become RMB hubs. This would further embed the RMB into global markets.

That same year also saw the issuance of the first dim sum bond in Hong Kong, corporate bonds issued in RMB-denominated funds. McDonalds, Caterpillar and HSBC Bank are some of the growing number of companies issuing dim sum bonds. In addition to the fund-raising benefits, the issuance of a dim sum bond has the added effect of signalling that the corporation is vested in China for the long haul.

In 2011, China published new rules to ease RMB foreign direct investment (FDI), as well as outward direct investment (ODI) by Chinese entities abroad. According to HSBC, total China ODI flow in 2011 amounted to US$74.65 billion, much of it going into the Asia-Pacific region, but a growing amount headed to North America.

And this year, two significant policy changes telegraphed to the world’s financial markets that China is still pushing free-market reforms. In April, the floating range of the RMB exchange rate to the US dollar was widened from 0.5% to 1%. And in June, China loosened its grip on interest rates, allowing them to move in both directions to a more balanced level, and allowing Chinese banks more leeway in setting rates against official benchmarks.

The appetite for the RMB around the world is growing. Commercial banks are launching a plethora of RMB financial products and services. Virtually any company in North America today can open a RMB-fund account. HSBC offers offshore RMB products and services ranging from hedging and derivatives, to bond issues, foreign exchange services, savings and investment products .

The RMB’s rise on the global scene is in the early stages and the journey won’t be completed overnight. But things happen fast in China-time and international companies need to get ready for the RMB.