Published: February 01, 2010
Since July 2009, companies with locations across South East Asia have been able to settle cross-border trade transactions with eligible firms in China in RMB. Most of the major international banks operating in the region have been quick to acquire the necessary licence and processing capability to enable their customers to take advantage of this opportunity. But as we start the Chinese Year of the Tiger, with all its associations of power and courage, what is this project likely to mean for companies trading in China, both now and in the future, and are we likely to see the Chinese authorities forging ahead to achieve full RMB convertibility and creating a world currency of the future? In this article, we showcase the views of four key experts in this field on the project today and the future potential of the RMB.
Banks supporting their clients’ trade activities in China have generally been optimistic about the scheme and its implications for their clients. With only a few months since the scheme was launched, it is perhaps too early to gauge its success, and initial optimism has had to be tempered with realism. Chris Lewis, Head of Trade and Supply Chain - Greater China, HSBC, sees the expansion of the scheme since it was first launched as a significant indication of success,
“The launch of the RMB trade settlement pilot project was a major event for us during 2009 and considerable progress has been made. It took a while to come to fruition but it has gone smoothly since. When the scheme was originally established, there were 365 MDEs that were authorised by the PBOC to conduct cross-border trade in RMB, initially in Hong Kong and Macau and latterly the ASEAN countries. Now, there are over 5,000 MDEs and additional cities, and further expansion is likely.”
Neil Daswani, Head of Transaction Banking, Northeast Asia, Standard Chartered Bank, concurs,
“There has been substantial progress in the expansion of the RMB pilot scheme since the first RMB cross-border trade transaction in July 2009. The number of MDEs (Mainland Designated Enterprises) was limited initially but this is expected to increase as more MDEs receive approval from the authorities, hence expanding the number of pilot cities in China.”
Lisa Robins, Treasury & Securities Services China Executive, J.P. Morgan, is more cautious, however, noting that,
“Although the project has been a success so far, adoption of RMB as a trading currency has not been as rapid as some anticipated. There are various ways that this could be accelerated; for example, the Chinese government needs to encourage companies to export/import in RMB, e.g., through tax incentives. In addition, their trading counterparties need to be comfortable with RMB risk. Even though the RMB is appreciating, risk is still an issue, even for an apparently strong currency.”
William Mor, Treasury and Trade Solutions Product Head for China, Citi, takes a similar view,
“The project is still in its infancy where it will take some time for corporates and financial institutions to adapt to the idea that RMB is an international currency. 2009 settlement flow remains low and estimated to be around in USD22m, a fraction of overall import and export settlement flows of over USD2.5 trillion.”
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With the number of cities and MDEs within the scheme growing, and awareness among firms in eligible countries developing, demand is likely to continue strongly during 2010. Chris Lewis, HSBC, explains the importance of ongoing education in attracting interest,
“We have seen considerable customer interest, such as in Hong Kong and the ASEAN countries. In particular, people want to know more about the project and its implications, so there is an education process going on, both with our customers and within the bank.”
But what advantages does the scheme bring, both for Chinese companies and their international trading partners? William Mor, Citi, puts the scheme into context, emphasising that in many ways it was a logical progression of what businesses were already doing,
“Even before the ability to settle trade flows in RMB existed, many Chinese corporates with sufficient bargaining power had priced their sales in RMB. When settled, the buyer would usually pay in an agreed foreign currency based on the settlement date exchange rate. There were even letters of credit being issued with settlement in the RMB-equivalent of a foreign currency.
“So, settlement and RMB trade is not new except that with the opening of cross-border RMB settlement, the seller can keep their receivables in RMB and use them for their RMB payables, which will help hedge their FX position. Offshore sellers will definitely prefer RMB over other currencies as the market prediction is that RMB will continue to strengthen for a long time until RMB is at a stable level where there is no longer political pressure to revalue RMB further.
“For companies in China, they will prefer to sell in RMB as it is their preferred settlement currency that is tied to their manufacturing costs. With this balance, they can maintain a stable margin for their product without having to incur any other hedging costs to protect the value of their receivables.
“Before the RMB exchange rate is stabilised, apart from inter company trade settlement where the terms of sale are easily negotiable, it will take some time for the companies to fully accept RMB as a settlement currency. RMB settlement will probably occur when companies with strong bargaining power can dictate their preference for RMB as their settlement currency.”
Neil Daswani, Standard Chartered, summarises some of the benefits,
“The benefits to Chinese companies being paid in RMB are fairly straightforward. These firms are able to reduce their FX exposure, reduce transaction costs and administrative overheads, and achieve faster tax rebate and settlement. On the flip side, this may open a window for foreign companies to negotiate better contract terms which potentially translate into working capital savings.
“In terms of FX risk considerations, if firms happen to have two-way import and export flows with China, it is a natural hedge for them. Otherwise, foreign multinationals may feel that they can manage the FX risk more effectively through their treasury policies.
“It is likely in the future that as more Chinese firms adopt RMB, those foreign firms that were willing to settle in RMB have an advantage of dealing with more trading partners in China which has far better access of local currency.”
Chris Lewis, HSBC, stresses the potential commercial advantages that can be obtained,
“There may be very valid commercial reasons for using the RMB. For example, a company importing from China may prefer to use USD; however, if the exporter offers a discount to trade in RMB, particularly on top of early payment discount, the advantage could be significant. A customer with whom we worked recently identified savings of 7% by trading in RMB for these reasons.”[[[PAGE]]]
As awareness of the scheme and RMB trading continues to grow, many people are looking at how it will develop in the future, and secondly, whether it heralds the RMB becoming a world currency. In both respects, Chris Lewis, HSBC, encourages caution,
Even though the RMB is appreciating, risk is still an issue, even for an apparently strong currency.
"Looking ahead, we should not expect to see very rapid change; after all, the Chinese government has typically taken a step-by-step approach to reform to avoid major disruption, and we would anticipate that this will continue. In addition, there will need to be a continuing education process across the world’s trading community and confidence that it is safe to conduct trade in RMB. Inevitably, these processes take time.”
Looking first at the pilot scheme, the PBOC will only expand the scheme if its terms are respected by existing participants. Chris Lewis continues,
“It is important that countries involved in RMB trade settlement implement new guidelines stringently and appropriately. For example, the Hong Kong Monetary Authority, which is responsible for implementing policies on the use of RMB in Hong Kong, has been very careful to implement PBOC guidelines properly, and other eligible countries will need to adopt a similarly disciplined approach.”
Neil Daswani, Standard Chartered, describes how the scheme is already evolving, a trend that is likely to continue,
“We expect that the authorities would be looking at alternatives to ensure the success of the Trade Settlement pilot scheme. In December 2009, we saw offshore companies being allowed to open RMB accounts in China. While the rules for this are still not fully released, we can expect that similar approvals in the short run will be granted, whether it is extending trade settlement to more MDEs, cities or countries. Allowing offshore companies to open accounts on-shore gets around some of the administrative challenges faced in approving MDEs, primarily around the faster export tax redemptions.”
He goes on to explore additional opportunities for cross-border RMB in the future,
“The financial products for offshore RMB should also eventually match what are being offered in USD, such as export financing, investment opportunity, derivatives and FX risk hedging products. In the longer term, we would expect the scheme to move beyond trade settlement. However all indications are that importance is being given to the success of cross-border trade settlement in RMB before other cross-border flows are opened up.”
The RMB cross-border trade settlement scheme is not a stand-alone initiative in terms of opening up the RMB internationally. For example, the anticipated de-pegging of the RMB from the USD will also be a significant step. Neil Daswani explains,
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“It will be interesting to see what impact the expected de-pegging of the RMB from the USD will have. With a resumption in gradual appreciation of the RMB, some exporters to China will find it beneficial to receive RMB (that they can freely convert off-shore), and hold it. Companies receiving RMB will not enjoy better savings rates relative to the USD, but could gain from currency appreciation of between 2-5% if economists are to be believed. This could be attractive in a low-interest rate environment.”
“In five years’ time, we would expect to see the RMB among the world’s major currencies, but the extent of its adoption internationally will depend on the degree of liberalisation determined by the Chinese government, regulatory authorities and the central bank. If these authorities continue down their current path, we would expect to see RMB as a ‘business as usual’ currency.”
However, William Mor, Citi, takes a stronger view of the RMB’s potential for the future,
“China is a global economic power house and has surpassed Germany as the world’s major exporter. With its strong economy and strong foreign reserves, China will continue to play an important role in the world economy. RMB will one day be an international currency and the market is predicting that RMB will replace USD as an international trading currency.
“With this direction set, it is important for trades to be settled in a stable and strong currency. RMB will gain a strong foothold in the short term and gradually, as RMB regulations ease, more corporates will hold RMB as their alternative currency, which in turn will encourage financial institutions to have RMB as one of their balance sheet currencies. With freely tradable RMB, foreign governments will start to consider RMB as a reserve currency.”
This is unlikely to be a short or entirely smooth journey, however. Neil Daswani, Standard Chartered, outlines some of the obstacles or features that will need to be addressed along the way,
“The RMB has to go through four major milestones before it could reach a world currency status, including,
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Today, the Chinese government is putting a tremendous amount of effort into turning the RMB into a currency used for commercial trade because they believe that in order for it to become a reserve currency, the RMB must first be accepted as a currency in which to settle international trade transactions.
China has achieved tremendous success in a short space of time in its economic development. However, other factors that will determine whether the RMB becomes a world currency include:
It is important that countries involved in RMB trade settlement implement new guidelines stringently and appropriately.
If (and potentially when) the RMB becomes a world currency, there would have to be a significant redenomination of USD transactions and perhaps in the longer term, USD reserves will be converted into RMB. It is very difficult to see what geo-political and economic impact this could have, but it would be comparable with or an even greater event than the move from sterling to the gold standard or the gold standard to the Bretton-Woods system. As it is perhaps still a stretch too far to anticipate what could happen in the future, the key at present, both in China and beyond, would seem to be to facilitate efficient trade and put the foundations in place for greater liberalisation. As Lisa Robins, J.P. Morgan, explains,
“As the RMB continues to evolve and play a more evident role on the world market, it will become another tool in corporates’ toolkit, alongside other major currencies. It also gives room to negotiate terms and conditions based on currency in a way that has not been possible in the past, according to the balance of power between importer and exporter.”
In conclusion, Chris Lewis, HSBC, summarises the key issues in the development of RMB will be perceptions of safety and stability, and the continuing economic fortunes of China. These factors would indeed seem to be the key to the future development of the currency,
“Currency strength is not simply about its value relative to other currencies, but its safety and stability. The launch of the euro changed the trading currency landscape. As a collective currency, it presented another stable currency on which trading counterparties could rely. Looking at the JPY, although Japan is the world’s second largest economy, it is not a major player in a financial sense, hence the JPY is little used as a trading currency. The RMB is set to become an alternative currency for trade, with China’s huge population and the likelihood that it will become the world’s largest economy.”
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