In the previous issue of Treasury Today in China, we provided an overview of the renminbi cross-border trade settlement pilot scheme. In this Business Briefing, we take a more in depth look at the issues facing those companies who are considering switching to renminbi as a trade settlement currency. We also look at the role that renminbi trade settlement plays in the larger scheme of internationalising the renminbi.
Introduction
China’s growing economic integration with the rest of the world is changing the way that companies in China do business, both within the country itself, and internationally. Moreover, significant pressure is being placed on the renminbi through the country’s rapid growth. As a result of this, Chinese importers and exporters are facing increasingly significant exposure to foreign exchange volatility.
“Government policy is therefore to move progressively towards internationalisation of the renminbi, encouraging its adoption as an international trade currency,” says Lisa Robins, Managing Director & Vice Chairman, China, Treasury and Securities Services, J.P. Morgan. “A cautious and phased approach to internationalisation of the renminbi is also consistent with the Chinese government’s habit of careful, measured development.” The pilot programme for cross-border trade settlement in renminbi, is a significant step towards the goal of renminbi internationalisation.
Programme snapshot
The Ministry of Commerce officially launched China’s first pilot scheme for RMB cross-border trade settlement in July 2009. The pilot programme originally allowed selected companies, known as mainland designated enterprises or MDEs, in five cities across China (Shanghai, Guangzhou, Zuhai, Shenzhen and Dongguan) to invoice and settle trade transactions in RMB. These locations were carefully chosen by the Chinese authorities as these are particularly active cities in terms of imports and exports.
Initially, the programme was only available for trades taking place between those designated cities and Hong Kong, and Macau but this was quickly extended to include the Association of Southeast Asian Nations (ASEAN). The PBOC has announced a new regulation to expand the pilot scheme to cover 20 provinces and municipalities in China as well as all countries/locations outside of China.
In addition, all eligible enterprises registered in pilot cities will be able to use the renminbi for cross-border settlement of both trade goods and services (previously only goods were permitted). Pilot enterprises approved by the PBoC who use the renminbi in cross-border goods export trading, will also now be able to benefit from an exported goods tax rebate (exemption) policy.
Evolution of RMB cross-border settlement
Before the pilot programme began, those mainland companies that were large enough to command a certain level of negotiating power were able to price their sales in renminbi. While the sales were priced in local currency however, the overseas buyer would usually settle the transaction in foreign currency, at an agreed exchange rate. Sometimes, even letters of credit were being issued in renminbi, but being settled in foreign currency. So the basis for an official programme was already in existence. The pilot scheme has taken things one step further, providing a formalised framework.
On 22nd June 2010, the Chinese government expanded the scope of the RMB cross-border settlement programme, removing many of the initial restrictions. This included expanding the corporate participants list. More corporates are now able to settle their exports in RMB and any corporate in the designated 16 provinces and four municipalities across China can settle their imports, service trades and current account transactions in RMB with counterparties globally.
Similarly, RMB payments from overseas can now be made into China for merchandise trade, service trade and all other current account activities. Removal of such restrictions has already brought benefits to corporates based onshore, such as a reduction in FX risk, since transactions are now settled in local currency, and yet have the same eligibility for export tax rebate incentives.
For those companies considering a switch to settling trade transactions in renminbi, a checklist of points to consider is provided below:
Should we switch to settling in renminbi? A checklist for CEOs and CFOs.
- Are the transactions concerned intercompany or with third parties? Converting to renminbi settlement will be easier in the former case.
- Do payables and receivables in renminbi roughly match each other? If so, this limits the risk of retaining renminbi on hand with limited investment vehicles, and foreign exchange exposure incurred in buying renminbi to settle future trades.
- If the company expects to receive more renminbi than it needs to pay, might it be more sensible to use USD instead of renminbi to settle the ‘unmatched’ amount?
- If the company expects to pay more renminbi than it receives, what hedging tools can be used to reduce foreign exchange risk, such as buying renminbi in the future?
- Could a ‘re-invoicing centre’ based in one of the eligible countries for renminbi settlement be set up to act as the only counterparty for all trades with China?
- Will the banking partner selected for renminbi settlement have the necessary expertise? Can it provide a consistent client experience for renminbi settlement, for example internet banking interface, client service model etc? Can it clear renminbi quickly enough?
Both Robins and Xu agree that further liberalisation of the scheme is the way forward in terms of growing renminbi trade settlement volumes. However, they also believe that the RMB cross-border trade pilot programme should be as a stepping stone on the way to the internationalisation of the renminbi, rather than a complete solution. So, what remains to be done?
The liquidity challenge
According to Xu, a key barrier to the development of the renminbi into a genuine international trade currency remains: the issue of liquidity. “At present, there is a very limited international market in the currency, and hardly any investment products or hedging tools exist,” says Xu. “This means, for example, that a supplier into China, persuaded to trade in renminbi by the customer, will face receiving renminbi which he can do little with other than place on deposit with limited return.”
“At present, there is a very limited international market in the currency, and hardly any investment products or hedging tools exist,” says Xu. “This means, for example, that a supplier into China, persuaded to trade in renminbi by the customer, will face receiving renminbi which he can do little with other than place on deposit with limited return.”
Sam Xu, Executive Director and Senior Product Manager, J.P. Morgan Treasury Services China
Since China is such a large scale producer of raw materials including oil and gas, it is possible that these renminbi receipts could amount to several million – so the numbers are by no means insignificant. Xu explains that, “Without adequate renminbi liquidity, most suppliers into China will remain reluctant to accept the currency, except in the lucky – and extremely unlikely – circumstance that they can be recycled one-for-one for Chinese purchases.”
Moreover, the absence of hedging ability is particularly important given that forecasts are predicting a significant appreciation in the renminbi, certainly over the coming years. As such, an overseas customer who commits to a long-term purchase agreement with a supplier in China, such as a programme of major equipment purchases which takes place over three-to-five years, has no way of offsetting the probable increase in their future payment obligations.
“Internationalisation of the Chinese currency therefore faces something of a chicken-and-egg situation,” says Robins. She explains that on the one hand, full development of interbank activity, together with international currency trading, renminbi investment and hedging products cannot take off until the renminbi becomes a true international trade currency. On the other hand, full internationalisation of the renminbi cannot happen until China’s overseas trading partners have alternatives to invest or hedge the currency.
Overcoming hurdles
In order to promote international renminbi liquidity, the People’s Bank of China has signed over RMB 650 billion worth of bilateral currency swap agreements with seven other central banks – Hong Kong, South Korea, Indonesia, Malaysia, Argentina, Belarus and Iceland. It is also hoped that this will support local trading activity with Chinese counterparties. According to Robins, Thailand and Russia are reported to be in discussion with China for the same arrangement and a handful of companies are now authorised to make a market in issuing renminbi bonds.
The role of international banks and Chinese authorities
“Non-deliverable forward contracts can in certain circumstances be an effective alternative to conventional hedging contracts, and J.P. Morgan, along with some other international banks, is offering these,” explains Xu.
While these steps from the banking sector are certainly a move in the right direction, the full internationalisation of the renminbi is still a long way off. If the renminbi is to become a true international trading currency, many more market makers outside China will need to begin offering similar services.
According to Robins, “The Chinese authorities appreciate the constraints imposed by the current lack of renminbi liquidity, and are working constantly with strategic partners to develop balanced, controlled but effective routes forward.”
“The Chinese authorities appreciate the constraints imposed by the current lack of renminbi liquidity, and are working constantly with strategic partners to develop balanced, controlled but effective routes forward.”
Lisa Robins, Managing Director & Vice Chairman, China, Treasury and Securities Services, J.P. Morgan
Looking to the future
For the true internationalisation of the renminbi to take place, it will be necessary for international banks to participate in a global renminbi market and therefore the appropriate settlement structure will also have to be accommodated. As Xu explains, “Only the global banks have the necessary balance sheet strength, global clearing capability, branch networks and correspondent bank relations which full-scale world trade in renminbi will require.”
It is widely understood that the use of renminbi in international trade is going to take time. As such, while steady progress is being made, trusted banking partners of the PBoC can help clients by raising specific issues and devising ad hoc solutions which can point the way towards future developments and also further liberalisation of current regulation.
Beyond the question of trade lies the issue of capital transactions. “Eventually, the Chinese government will have to ease the current prohibitions on free capital inflows and outflows if China is to play a full role in the global financial economy,” says Robins. As yet, however there are no real signs of liberalisation to this extent. It is thought that the broad acceptance of the renminbi as a trade currency will be the first step towards such a shift in policy, with the government becoming more comfortable about the full implications of such a move. These are interesting times for China.
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