China’s dramatic growth in international trade has made it the second largest economy in the world, as well as the largest exporter. The Chinese Renminbi (RMB) is currently the fifth most common currency in global usage, according to SWIFT, with the growth of usage expected to continue.
Over the last few years, the Chinese government has undertaken a process to liberalize and internationalize its currency, the Chinese Renminbi (RMB), relaxing some rules to move in the direction of allowing its currency to become more freely usable and tradable. This includes expanding the use of the Chinese Renminbi (RMB) for global trade settlement, encouraging a robust offshore renminbi environment, and deepening markets for RMB to be utilized as an investment currency.
The People’s Bank of China (PBOC) is laying the groundwork to have the RMB currency become a global currency in a three-step process:
1. RMB as a global trade currency
As the RMB develops as a trade currency, businesses are becoming accustomed to using it for payments and receipts for goods and services.
2. RMB as a global investment currency
The goal is to allow global investors to invest using the RMB by providing robust channels and investment options to RMB assets on par with other currencies and global markets.
3. RMB as a global reserve currency
The government wants its currency status to match its position as an economic leader. China would like to see RMB adopted as a reserve currency by central banks around the world.
In the past, RMB’s international usage was minimal, and while China’s domestic trade and business activities were settled in RMB, cross-border trade in RMB was not allowed and needed to be in foreign currency, such as the USD. With China undertaking the initiative of internationalizing the currency, liberalizing cross-border trade settlement was the natural first step, given the significant international trade activities in China. As a result, trade of goods and services in and out of China can now settle in RMB. The RMB now trades directly against most major currencies, adding depth to the RMB foreign exchange market.
To facilitate this cross-border flow, companies domiciled outside China can use RMB freely for cross-border trade settlement with their trading partners, as well as open RMB accounts both in mainland China and offshore, including the U.S. Capital transactions, including registered capital for companies setting up in China, can also now settle in RMB. There are also plans in place to eventually expand cross-border RMB settlement to individuals in China, albeit gradually.
To further the goal of RMB internationalization, the People’s Bank of China (PBOC), China’s Central Bank, continues to develop Shanghai as a global financial center. In addition, new offshore clearing centers have recently been added in Switzerland, Australia, Canada, and in the U.S., where a RMB clearing bank was designated in New York. These developments show a commitment by a growing number of countries and regions to further utilize the currency.
In addition to becoming a global trade currency, the RMB is also moving toward being accepted a global investment currency, as offshore RMB may now be used for capital investment. The RMB is viewed as an asset class, with market participants using the currency as an investment vehicle both onshore and offshore. RMB can now be held and invested offshore in various RMB centers, such as Hong Kong, Singapore, London, Frankfurt, etc., In February 2016, the China Interbank Bond Market was created to allow foreign institutional investors access to bonds traded onshore in China, bolstering RMB’s depth as an investment currency. Programs such as Shanghai-Hong Kong Stock Connect, Bond Connect, and most recently, Shanghai-London Stock Connect that was launched in June 2019 provide additional access and depth to the market.
On the reserve currency front, the International Monetary Fund (IMF) has included the RMB in its Special Drawing Rights (SDR) basket of currencies as of October 2016, positioning the RMB as a global currency, in the same IMF category as the U.S. Dollar, British Pound, Euro and Japanese Yen. Since the SDR inclusion, Central Banks around the world have been adding RMB to their portfolio, reaching 1.84% of total global currency reserves, according to 1Q 2019 IMF Data. While there is more progress to be made in RMB’s internationalization quest, the SDR inclusion is a significant milestone, and may serve as a catalyst for further reform.
RMB Exchange Rate Trends
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The RMB has experienced greater volatility in the past three years driven mainly from PBOC intervention and U.S.-China trade disputes. Shortly after President Trump took office in 2017, the PBOC began to intervene in the market with stronger fixings to discourage speculators from betting against the RMB. Throughout 2017, the RMB appreciated from not only PBOC actions but stronger China economic data and a broadly weaker dollar.
The RMB appreciation came to a quick halt at the end of 1Q18 as trade discussions between the U.S. and China escalated. President Trump was accused by China of igniting the trade war, while China was accused of being a currency manipulator by President Trump. The PBOC, in response to the trade tension, signaled its desire to weaken the RMB. The PBOC adjusted its daily fixings for the currency (weakening the RMB) during the second half of 2018 to spur exports as a method of reducing the negative impact of US tariffs.
After topping out just short of 7.0 USD/CNH in October of 2018, the RMB appreciated for about six months on widespread optimism that the world’s two largest economies would come to an agreement on trade. In May 2019, the U.S. imposed 25% tariffs on $200 billion USD worth of Chinese goods (up from 10% previously), which drove the RMB back to 2018 lows near 7.0. At the G-20 Summit in August 2019, President Trump and China President Xi were again unable to come to an agreement on trade, though Trump announced that the new tariffs would be suspended for the time being while trade talks restart.
Only weeks after this announcement was made, the Trump administration decided to impose another 10% tariff on $300 billion USD worth of Chinese goods by September 2019 (though some tariffs will be delayed until December). This action sent the RMB tumbling past the psychologically important level of 7.0 RMB per USD for the first time since 2008. In a statement, President Trump said he believes this move was the result of currency manipulation from China in order to gain an unfair trade advantage. The International Monetary Fund has not supported that statement. The new round of tariffs and the currency manipulation accusations have only further increased the tensions between the two nations.
After a long stalemate, the United States and China resumed negotiations at the beginning of October 2019. Negotiations thus far have been encouraging as officials from both nations have shown a willingness to come to an agreement. A partial agreement was announced earlier in October and is being considered “phase one” of a larger agreement. Part of the agreement includes a suspension of tariffs increase that was scheduled to take effect in October, purchases of U.S. agricultural products by China, as well as policies addressing intellectual property rights and financial services concerns. Phase one could be signed by mid-November, according to President Trump.
Going forward, even though a partial deal has been loosely agreed upon, uncertainty remain that a comprehensive trade deal is not struck between the U.S. and China, dragging on the back and forth of tariffs and retaliatory measures by both sides, which may bring further volatility to the RMB currency.
Transacting in RMB vs. USD
U.S. companies have historically believed that negotiating international agreements in USD insulates them from exposure to currency volatility. However, this practice often puts them at a competitive disadvantage compared to companies that transact in local currency since there are hidden costs in USD pricing.
With China’s changing currency regulations, U.S. companies are learning that conducting business in the RMB instead of the USD could be beneficial. The PBOC has estimated that due to embedded premiums and transactional charges the administrative cost alone of transacting in USD is 2–3% higher than dealing in local currency. Hedging tools and RMB multicurrency accounts are now readily available to actively manage currency risk when transacting in the RMB currency.
The acceptance of the RMB as a trading currency and the growth of the offshore market provide opportunities for U.S. importers, exporters and investors to benefit from these developments.
For further discussions or additional information about RMB internationalization, please contact your PNC relationship manager.