Opening China’s capital account is only half the story Nearly four years after the first push to internationalise the Renminbi (RMB), Chi Lo, senior strategist for Greater China, BNP Paribas Investment Partners, and a speaker at the session on RMB internationalisation discusses why momentum has stalled and what China needs to do next.
How has the internationalisation of the RMB to date been influenced by regional and global macro economic developments?
The internationalisation of the RMB has not been influenced much by global economic and monetary developments, be it quantitative easing in the US or the European debt crisis. I think it’s because, firstly, the RMB has not been a major currency on the world financial stage. And secondly, China still has a closed capital account. This means international events don’t really affect China directly. Asia is where the momentum of the RMB internationalisation comes from. Outside of Asia there is only limited usage of RMB for trade.
Has momentum stalled? If so, what is causing this?
Momentum of RMB internationalization has slowed down quite a bit since the middle of 2011, as the maximum impact of deregulation was reached. Note that the internationalisation of the RMB is mainly driven by Chinese importers settlements. When we look back to 2009, when China first started pushing its currency for trade settlement, only about 300 Chinese companies were allowed to use RMB for trade settlement. Between the middle of 2009 and Q1 2012, those restrictions have been scrapped steadily. Now, all Chinese companies can use it. This has resulted in the near maxi- mum amount of RMB outflow through imports being reached. Take Hong Kong, for example, where RMB is used for 90% of its trade settlements with China.
What does China need to do reignite momentum?
Trade is not enough to internationalise RMB – it’s only one aspect. The next step for RMB internationalisation is allowing offshore centres – London, Toronto, Hong Kong, Singapore, etc. – to create RMB-de- nominated assets. This will create incentives for foreigners to hold and trade RMB. Certainly, China has done some things around this since late last year. The country expanded the QFII (Qualified Foreign Institutional Investor) and RQFII (RMB Qualified Foreign Institutional Investor) quotas, and the allowance of using RMB as a foreign direct investment currency to invest back in China. All of these moves help foreigners access the Chinese asset market onshore.
Have these changes made a difference?
We’ve seen some progress, but it has not been satisfactory in terms of foreigners using the QFII and RQFII quota. The total QFII quota now is USD 80 billion, but less than half of the total has been taken up. The RQFII limit is RMB 270 billion, and again about half of that has been taken up. Why? It’s a reflection of the lack of foreign interest. One big reason is because of the global financial turmoil. All this is creating risk aversion, and RMB assets are one of the risk-asset classes.
What does China need to do next to capitalise on opportunities?
Risk appetite will come back when market sentiment returns. But China needs to address its structural issues to attract foreign demand. Opening the financial accounts and creating incentives for foreigners is one thing, but China also needs to build up the credibility of its economic and government policies. The term ‘Impossible Trinity’ strikes at the heart of what China needs to do next. This means when you have an open capital account, you can only control interest rates or exchange rates, not both. China still has a closed capital account and still controls both exchange and interest rates. This will have to change to truly internationalise the RMB. China will have to open the capital account completely, eventually. The difficulty is that opening the capital account will lead to capital flowing in and out freely, and the immediate question is: can the Chinese system withstand that? Of course it can’t. There are a lot of structural problems with the banking system, the corporate sector and the capital and bond markets. There’s a whole series of structural reforms needed.
What are your predictions for the future?
I think a tipping point will be reached, but I don’t think we can pinpoint a timeframe for that. Theoretically, it will be when China’s capital account is opened wide enough, causing significant increases in financial transactions of the RMB, in addition to trade, in the global markets. I don’t see this until at least another five to seven years down the road. The offshore RMB market will no doubt grow many times larger than it is today, with new offshore centres, such as London, Singapore, Tokyo and New York being added to build the overseas trading momentum for the RMB over time.
The above article originally appeared in the Thursday 19 September 2013 publication of Sibos Issues.
Jonathan Batten’s research, co-authored with Peter Szilagyi, presented at the Sibos RMB Internationalisation session, can be downloaded here.