In 2014, China’s central bank warned the market to expect more two-way volatility in the renminbi (RMB) over the coming years and, in recent months, that is exactly what we have seen. The 2% downward adjustment that took place in August 2015 sent those who trade in the currency on a roller-coaster ride. What else can treasurers expect as the People’s Bank of China (PBoC) releases the currency into the hands of market forces?
According to figures from the IMF, China took over from the US as the world’s largest economy in 2014. Yet, in comparison to the country’s economic advancement, its currency has struggled to achieve global adoption. This is something that China wants to change and over the last few years the country has begun a process of liberalisation.
To date, these changes have largely been considered a success and have seen the renminbi move from the 20th most traded currency just three years ago to the fifth most traded today. The first, and perhaps most significant move by the Chinese authorities in recent years, was the launch of the Shanghai Free Trade Zone (SFTZ) on 29th September 2013. The zone is a testing bed for economic and social reforms, including financial deregulation to drive the opening of the economy, liberate the currency and improve the foreign investment process. If successful these reforms are rolled out nationally.
Since the launch of the zone, the most noteworthy development for corporate treasurers has been the ability to implement cross-border RMB sweeping structures, giving corporates the opportunity to bring China into their global/regional cash management structures. The regulators introduced limited one-way sweeping in 2013 and then established two-way cross-border sweeping in the SFTZ in the first half of 2014. The ability to establish two-way cross-border RMB pooling structures was subsequently extended nationwide. Organisations simply elect one of their companies to become the cross-border pooling entity, which is then used to centralise cross-border payments and collections and to net cross-border settlements. This allows corporates to avoid having to seek approval from the State Administration of Foreign Exchange (SAFE) each time they transfer funds cross-border.
A number of other initiatives have also been trialled in the zone including removing documentation from processes, reducing the list of banned industries for outside investment, and preferential tax rates, to name but a few.
Elsewhere, the creation of offshore RMB clearing centres has been a key pillar in the internationalisation of the Chinese currency. Since the first offshore clearing centre was established in 2003 in Hong Kong, there has been a proliferation of centres around the world (there are now 16 in total), especially in last 12 months, as usage of the currency has increased.
The creation of RMB clearing centres has primarily been regarded by the Chinese government as a way of internationalising the currency, whilst limiting the exposure its domestic financial system has to the rest of the world. To do this, the PBoC authorises a bank (typically a big four Chinese bank) in the chosen country to act as a conduit between the onshore and offshore markets and clear RMB transactions locally.
By doing so, corporates operating in these centres are able to begin to access RMB products, open RMB accounts and use the currency to make payments to both onshore and offshore counterparties. The primary benefit of this is that, in theory, it makes it easier and less risky for business to be settled in the Chinese currency, as the designated clearing bank in these countries can purchase a limited amount from RMB from the onshore market, should the offshore market lack liquidity. Countries that have currently been designated RMB status include: Hong Kong, UK, Singapore, Germany, Luxembourg, South Africa and Taiwan.
The next step for Chinese payments is the launch of the China International Payments System (CIPS). The system, billed as the new RMB superhighway, is set to go live later this year although in limited form initially. CIPS is discussed in more detail on page 11 of this supplement.
All of these changes are pushing the RMB in one direction – towards becoming one of the world’s dominant currencies and eventually a global reserve currency. China has recently expressed its desire for the RMB to be included in the IMF’s basket of reserve currencies and a decision is likely to be made by the end of the year.
If included, the RMB will be given the same status as other leading currencies such as the dollar, pound and yen, cementing its place as a global currency. Although inclusion has little practical impact given how the international monetary system has developed, it will give a big symbolic boost to the currency and will encourage other nations to hold it in reserve, further promoting its use internationally.
There are two criteria which impact whether a currency is included in the IMF’s Special Drawing Rights (SDR) basket; the currency has to be freely convertible and the country of its origin has to be a major trader. China certainly meets the latter, but until recently, the former was still up for debate. Now that it seems clear that the PBoC will allow market forces to play a bigger role in determining the value of the currency moving forward, a paradigm change is under way. Indeed, recent volatility in the currency should be seen as the latest step in the RMB’s journey to meeting the IMF’s SDR criteria.
For the corporate treasurers of Chinese and non-Chinese companies alike, industry experts believe a more volatile RMB is likely to increase the focus on risk management, especially as central bankers in nearby economies look to respond with their own adjustments. Corporates and investors should therefore look to rebalance their portfolios and turn their thoughts to hedging activities.