As the renminbi crosses new milestones, there is renewed talk of it replacing the dollar as the worldâs reserve currency. But that event is still a long way off, finds George Mitton.
Swift, the international settlements service, declared at the start of the year that the Chinese renminbi had overtaken the Canadian and Australian dollars to become the fifth most-used payments currency. The milestone, said Wim Raymaekers, head of banking markets, confirmed the renminbi’s “transition from an ‘emerging’ to a ‘business as usual’ payment currency”.
There are moves to use the renminbi in all-important energy markets too. The Shanghai Futures Exchange is reported to be working on a plan to price crude oil futures in renminbi. Meanwhile, commentators have seen, in the establishment of an offshore renminbi centre in Doha, the potential to price Qatar’s liquefied natural gas exports to China in the Chinese currency too.
Naturally, analysts have been considering the next steps, predicting the renminbi will soon leapfrog the Japanese yen to become fourth in Swift’s list. From there, there is only the British pound, the euro and the US dollar to go. But will the renminbi ever challenge the dollar’s dominance as the world’s reserve currency? Despite the excitement over the Chinese currency, it seems the answer is: not for some time.
ENTHUSIASM
One counter to the enthusiasm about the renminbi is to look at the numbers behind Swift’s league table of payments currencies. As of December, the renminbi accounted for 2.17% of world payments by value, according to Swift. It seems very likely that the renminbi will soon overtake the 2.69% achieved by the yen in December. But the payments value will have to more than triple to overtake the British pound and increase 13 times over before it leapfrogs the euro. The dollar, meanwhile, accounted for 44.6% of world payments in December, according to Swift – more than 20 times the amount denominated in renminbi in the same period.
“The renminbi is fifth in the Swift ranking but, if you look at absolute amount of settlement, it is still very small,” says Chi Lo, senior strategist for Greater China at BNP Paribas Investment Partners. “Even if you quadruple the amount today in the next three or four years, it is still a small currency.”
Lo maintains that the enthusiasm about the growth of the renminbi has tended to conceal the fact that any seismic shifts in the reserve currency system will take a long time to occur. Although he agrees with the direction of travel of the renminbi, his near-term prediction is for the Chinese currency to establish a position as a “distant third” from the euro and the dollar in world trade.
This will have significant effects, but it is a far cry from the renminbi dislodging the dollar and ushering in a new era in world finance.
Part of the reason for Lo’s cautious prediction is that he believes the importance of internationalising the renminbi may have been overstated. This internationalisation process has been a key theme in Asian financial markets in the past few years, beginning when China gave approval to use the renminbi for trade finance, continuing with the establishment of the dim sum bond market, and more recently with the setting up of offshore renminbi centres in a number of countries. But Lo argues renminbi internationalisation “is not at the top of the agenda” for Chinese policymakers.
The main concerns of the government in Beijing, he says, are to help deliver economic growth and minimise risk in the financial system. Internationalising the renminbi is not directly related to either goal and, indeed, has the potential to bring volatility and risk into the system if it is not pursued gradually. This is because completely internationalising the currency implies scrapping China’s capital controls, and “the very near-term risk would be massive capital outflow – it is clear in Beijing’s mind that this risk is not negligible”, he says.
Indeed, it could be argued that fully internationalising the renminbi could jeopardise China’s reform agenda. As a result, says Lo, Beijing will pursue internationalisation of the renminbi slowly and carefully, and as a secondary project to its main concerns, which are purely domestic.
Replacing the dollar as the world reserve currency would, of course, imply a further change – that China would have to end the managed peg by which it sets the value of the renminbi to the dollar. Perhaps this will happen in time, but in the short term, the Chinese authorities seem unwilling to let go of this means of controlling their currency. Indeed, the latest trend from the central bank points to more intervention, not less.
STIMULUS
“In China, the policy easing of the past quarters is not really working,” says Maarten-Jan Bakkum, senior strategist, multi-asset, responsible for emerging markets at ING Investment Management. “Therefore, more stimulus is probably on its way.”
Bakkum predicts more fiscal spending, more quasi-government spending through public development banks, more monetary easing, reserve requirement ratio cuts and more currency depreciation.
Yet even with this raft of measures, he predicts growth in China will fall to 6.3% this year, lower than the recently reduced estimate of “about 7%”, which Chinese premier Li Keqiang delivered to parliament in March.
Bakkum’s pessimistic estimate is based on what he sees as “large structural problems that are not really being solved”, including misallocation of capital, overcapacity in industry and a sharp rise in debt-to-GDP.
In this challenging environment, it seems irrational for the Chinese authorities to pursue policies, such as liberalisation of Chinese capital accounts, that have the capacity to threaten stability. Instead, it is likely that full internationalisation of the renminbi will remain a secondary concern while the government focuses on growth and minimising risk.
How can asset managers position themselves for a gradual and lengthy rise of the renminbi, as opposed to a rapid one? Naturally, they will have to take a long-term view. Funds launched under the various schemes that allow access to Chinese assets, such as the RQFII scheme, are a useful part of a product offering, but they will not be the whole part, and asset managers should prepare for setbacks if there are changes of direction from the Chinese authorities.
(One imminent setback to QFII and RQFII funds is that Chinese authorities have signalled they will charge 10% capital gains tax on these products in the five years to November 2014, which may require asset managers to claw back gains from their investors.)
Equally, managers should take a crafty approach to setting up and managing operations in China, as they work out which is the best way to gain exposure to the Chinese market, something that will only become clear over time.
BNP Paribas Investment Partners, for instance, has both a joint venture in China, called HFT Investment Management, and a recently established wholly foreign-owned enterprise (WFOE) in the Shanghai Free Trade Zone. The firm is keeping its options open and preparing for the gradual opening up of China’s capital markets.
There are some positive signs, though. Although China’s banking sector remains dominated by state-owned enterprises, which the government seems unwilling to expose to competition from international firms, the country does seem to want to become more open, and may do so selectively. There’s a chance asset managers could benefit.
“It could be that asset management is the part of the financial sector where China can open up more easily,” says Karine Hirn, a partner at asset manager East Capital, who is based in Hong Kong.
“They also want the local asset managers to reach higher standards.”
©2015 funds global asia