As China moves increasingly to cement its role as an international economic power, the internationalization of its currency, the renminbi (RMB), plays a key role. Little used as a means of trade and investment outside China, the RMB is slowly but insistently promoted by Chinese authorities around the globe.
The use of the RMB outside China has grown steadily since the project was launched in 2009. But Paola Subacchi, research director of international economics at Chatham House, says the development of the RMB into a truly global currency is held back by the tight grip policy-makers in Beijing still have on it, by foreign investors’ uncertainty where the process of internationalization is heading and by China’s inability so far to assuage doubts about the future of its monetary policy.
The current two-pronged push to expand foreign use of the RMB promotes the use of renminbi in cross-border trade while creating an offshore RMB market. But Subacchi cautions that this internationalization process is essentially a temporary measure. “It’s a way to overcome the lack of convertibility,” she says, “a process to increase the use of the renminbi while China is preparing the ground for the renminbi to become a ‘normal’ currency.”
Subacchi views the outward push as “one step in a long and complex process of developing the currency,” which fits alongside wider moves to reform interest rates and the financial sector, and even improve corporate governance. The center of the expanding RMB offshore market is Hong Kong, the traditional trade conduit to mainland China, which currently handles over 60% of China’s foreign direct investment and more than 80% of all RMB payments.
In 2011, China moved to boost the use of the renminbi in Europe by choosing London as a second RMB offshore center, albeit reliant on Hong Kong for its liquidity. The European market shows great potential, accounting for 47% of the total value of RMB payments in the first quarter of 2012, more than the entire Asia-Pacific region. But in terms of investment in RMB-denominated financial products, the European market is held back by doubts over the currency.
LONDON LESS KEEN THAN HONG KONG
“If you talk to people in Hong Kong,” says Subacchi, “lots of investors are happy to hold renminbi in their portfolios because of the proximity to China, because they understand China and its policies and political dynamics. But if you talk to people in London, they are considerably less keen to hold renminbi in their portfolios, because they see it as a non-convertible currency.”
The government’s control over the renminbi is viewed by many as a major liability, with the currency potentially subject to the whims of Beijing policy-makers. The task of building this necessary trust with Western investors is “really very difficult,” Subacchi says. “There isn’t a series of policies they can implement. People need to trust the government, that the government will apply the rule of law and not do anything to completely change the policy or undermine the currency.”
The internationalization of China’s currency marked another milestone in September, with the launch of the Shanghai Free Trade Zone (FTZ). China’s State Council declared that the zone would play host to a “pilot and test” of a convertible renminbi capital account, making the zone China’s first onshore RMB market center. In the weeks following the official opening of the FTZ, however, foreign investors still have only a murky sense of what exactly the zone is and how Chinese authorities intend to pursue their stated goals within its boundaries.
POTENTIAL OF SHANGHAI FREE TRADE ZONE
Foreign banks in particular have been hesitant to set up branches in the Shanghai FTZ. So far, six foreign banks have applied for and received approval to open branches in the free trade zone, with others preferring to wait until more concrete regulations are unveiled. Subacchi sees little cause for concern in this official opacity, a standard approach to new and potentially risky projects that has been seen many times before.
“In 2009, when the pilot scheme for RMB trade settlement was launched, nobody really knew what it was, and not even the authorities had a clear idea,” she recalls. “In a very Chinese fashion, there was a case of moving step by step, ‘crossing the river by touching the stones,’” explains Subacchi, using a phrase commonly used to describe Deng Xiaoping’s cautious approach to introducing China’s first post-Mao market reforms. “They literally created a policy, tested the market reaction, and moved on.”
Those familiar with China’s strategy are well aware of the potential of the Shanghai Free Trade Zone. “There is a lot of concern in Hong Kong that Shanghai might overtake them and become the key financial center,” Subacchi notes. “At the moment, the authorities have been very careful to reassure Hong Kong that this is not going to happen.”
Given the pivotal position Hong Kong holds in the offshore RMB market and the ambiguity surrounding Shanghai’s nascent role, a shift in the balance of power is unlikely anytime soon. Subacchi stresses, however, that while the expansion of offshore RMB centers is key to China becoming a major presence in global financial markets, Chinese authorities are building a system to last. “We have to be clear,” she cautions. “Eventually the renminbi will be a fully conversable currency. Therefore there will be no need for this kind of construction, and Hong Kong in particular will be less relevant as an offshore center.”
Similarly, the importance of London and other cities hand-picked by Chinese officials as RMB trading hubs will also diminish once control of the currency eventually leaves the official domain for that of the market.