June 19 marks a year to the day that China’s government announced with much fanfare that it was ready to start loosening the peg that had kept its currency tied to the U.S. dollar since 2008.Ever since, the renminbi-dollar exchange rate remains in the news, and on the agenda of economic summits between U.S. and Chinese officials, like the one just held in Washington, D.C. in early May. However, while policy makers from the world’s two largest economies have been embroiled in endless debates on how much and how fast the renminbi should be growing stronger, experts say another key trend has been developing with equal significance for global business: That the renminbi, slowly but surely, is becoming a global currency.
Thanks to steady policy shifts over past months, more and more local and domestic companies are using the renminbi outside China to expand their capital raising and cash management options. Several international banks are offering renminbi trade settlement services, while Hong Kong — the testing ground for Beijing’s monetary strategists — also now has a market for renminbi-denominated financial products open to international investors. Meanwhile, the amount of renminbi deposits held by foreigners in Hong Kong has jumped to RMB 451.4 billion (US$69.4 million) as of early May from RMB 280 billion six months previously, according to the Hong Kong Monetary Authority.
The First of Many?
Getting the most attention amid these changes has been the small wave of Western multinationals that have issued offshore renminbi-denominated bonds to help finance their operations in China. That began last August, when McDonald’s, with nearly 1,300 restaurants in China as of the end of last year, became the first foreign multinational to launch a renminbi-denominated bond in Hong Kong — or "dim sum bond," as such instruments are now called. The private placement of the RMB 200 million, 3% notes due September 2013 followed the lead of a handful of foreign financial firms, which have been allowed to issue onshore renminbi bonds since 2009, or the so-called "panda bonds."
Next up was Caterpillar, which has more than 7,700 employees in factories and R&D sites across China. In November, the U.S. construction and mining equipment multinational launched a RMB 1 billion, two-year bond in Hong Kong. According to its bankers, the placement was oversubscribed quickly and press reports at the time said Caterpillar had received approval from Chinese authorities to repatriate the renminbi it raised to mainland China. "This was a successful issue," Richard Lavin, Caterpillar’s group president of emerging markets, told The New York Times. "Before, we were funding our operations by bringing in dollars and changing them to renminbi."
More recently, Anglo-Dutch Unilever hopped on the bandwagon this spring with a RMB 300 million, three-year issuance, to become the first offshore renminbi bond from a European multinational and the first from the fast-moving consumer goods sector. Observers say the size of Unilever’s manufacturing operations in the country, serving both local and international consumers, may encourage it to also eventually become the first nonfinancial foreign firm to seek Beijing’s approval to issue a panda bond.
As for China’s companies, they have been able to move renminbi offshore for investment purposes since January. The central bank has said Chinese enterprises can use renminbi to fund acquisitions and launch businesses overseas. However, they still need government approval for investing abroad, whether they settle in renminbi or in foreign currencies.
Of Currencies and Confidence
Experts from Wharton and elsewhere say corporate use of the renminbi is still limited and in pilot stages in many cases. But the new channels enabling funds to flow in and out of China are an important step in Beijing’s plans to make its currency a reserve currency alongside the dollar and euro and reduce the global reliance on the dollar.
"It’s a good thing – good for China and good for the global financial system," says Franklin Allen, professor of finance and economics at Wharton. "If we eventually have three global reserve currencies, currencies that can form the basis of reserves and global trade, this helps things a great deal. It means everyone is not relying on the dollar, and it introduces competition so people can go to the euro, and the renminbi, when it helps."
Beijing’s efforts to increase the profile of the renminbi outside China’s borders for trade transactions also are attracting the attention of authorities in other countries seeking to diversify their reserves from the U.S. dollar. For instance, South Korea’s central bank has just announced that it plans to invest some of its foreign exchange reserves in renminbi-denominated assets. Although Chinese financial markets remain mostly closed to foreign investors, Seoul is applying for a quota under a Chinese program for foreign institutional investors. Beijing to date has granted US$21 billion in quotas to about 100 foreign investors, including the central banks of Malaysia and Hong Kong.
For China, a more relaxed flow of dollars in and out of the country means it won’t need to keep such a vast pool of reserves, Allen adds.At more than US$3 trillion as of early May, China had the largest pile of foreign reserves in the world, much of which is in U.S. securities. "It’s painful for them that they have these huge investments in dollars – effectively, they have more than 50% of their GDP in foreign exchange, so they lose every time exchange rates go up."
Since last June, the renminbi itself has gained around 5% against the dollar, which is still not enough to correct global trade imbalances that make China’s exports far cheaper than goods produced elsewhere, say many China critics.
From the corporate perspective, Allen points out, a renminbi issuance is one way to hedge the risk of investing in and doing business in China. "It’s always better trying to balance assets and liabilities in the same country," he says.
Renminbi issuance also is a strong indication of the currency’s increasing acceptance in global business. Mike Richard, corporate treasurer of McDonald’s, says the fast-food giant plans "to continue investing in China by opening new restaurants, ‘reimaging’ existing restaurants and rolling out convenience initiatives. We see China as an important long-term growth market."
According to Aswath Damodaran, professor of finance at New York University’s Stern School of Business, "I do think it is a sign that a currency is being accepted internationally when foreign companies issue bonds in that currency. When companies don’t quite trust a currency, they prefer to issue bonds in dollars or euros and then hedge their currency risk with derivatives." Other signs of confidence in China’s currency to watch for, he says, include whether foreign firms operating in China do capital budgeting, project analysis or rates of return in renminbi or another currency.
Far and Away
Outbound mergers, acquisitions and green field investments by Chinese companies are also at a turning point. A recent report by Asia Society, a New York City-based non-profit, estimates that the value of such investments in the U.S. alone increased threefold from 2009 to 2010, to US$5 billion (which accounts just 0.1% of China’s foreign direct investment). If that acceleration continues, Asia Society’s report predicts that foreign direct investment by corporate China could reach between $1 trillion and $2 trillion worldwide over the next decade.
Marshall Meyer, Wharton management professor, says China has three goals involving outward investment. The first is securing natural resources, especially energy, to fuel its industries at home. Then there are new and strategic technologies, especially "green" technologies. "In both cases, they will invest in order to get a little more market power. Strategically, they don’t want to feel dependent; they’d like to have control," he says.
"A third driver," Meyer continues, "is how they are going to invest their foreign reserves. In a sense, buying companies may be better than buying T-bills." According to a new report from the U.S. Treasury Department on Beijing’s massive foreign exchange reserves, diversification has already begun. At the end of June 2010, China’s total dollar debt was US$1.6 trillion, but with total reserves growing at a faster rate, the share of reserves held in dollars was down to 65% in 2010 from 74% in 2005.
As Meyer puts it, "While the trends in investment abroad by China have been going on for more than five years, what we’re seeing today is more of it, and on a somewhat larger scale. The folks in government know that their trade balance must inevitably turn negative, and when it does they will want a fully convertible and stronger currency."
Beijing’s Balancing Act
While Beijing grapples with difficult tradeoffs in managing its currency policy, the pace of the renminbi’s appreciation, still tightly managed by the country’s central bank, has been quickening. Experts say Beijing is shifting emphasis from buoying growth to subduing inflationary pressures at home. Meanwhile, foreign policy considerations are at work, with not only the U.S., but also India, Brazil and several other countries, voicing concern about what they see as the renminbi’s continued artificially low value.
While the renminbi has appreciated by about 5% against the dollar in nominal terms over the past year, and passed the symbolic threshold of RMB 6.50 to the dollar at the end of April, the appreciation has been even greater in real terms – roughly 10% – because inflation in China is higher than in the U.S.
"The central bank and economic policy makers attached to Premier Wen Jiabao know that it is in the country’s macroeconomic interests to engineer a smooth, gradual appreciation of the renminbi, to keep inflationary effects and the huge pile-up of foreign exchange reserves from getting out of control," says Christopher Mark, former U.S. government official, who is now head of The Signal Group, an economic and competitive intelligence firm based in the U.S. and China. "On the other side, however, is the Commerce Ministry, which represents the interests of domestic manufacturers and low-end assemblers, who tend to operate on thin margins and will be hammered by a more expensive renminbi." Supporting these interests are powerful local and provincial leaders, who worry about rising unemployment and labor unrest if the cost of living continues rising.
At the same time, money is once again pouring into China, drawn by growth prospects and rapidly inflating asset prices. Ominously, some say, China could face a destabilizing bout of speculative pressure on the renminbi if "hot money" bets on further renminbi revaluation. Some experts say the increase of nearly US$200 billion in foreign reserves during the last quarter was likely spurred by such hot money.
"The key players in Beijing all remember very well the role that speculative capital flows played in destabilizing Southeast Asian economies during the regional financial crisis of the late 1990s," says Mark. "So Chinese officials also are quite anxious to dissuade currency market participants from making one-way bets against the renminbi. They’ll try to convince them that the exchange rate will move down as well as up."
All of which means that Beijing’s efforts to internationalize the renminbi over the coming years are part of a steep learning curve. "They’ve opened up a little bit," says Wharton’s Allen. "What they could look at next is what happens if they let ordinary people take out a limited amount of money [out of the country]. How much demand would there be? It would let some pressure escape, but primarily it would allow them to learn."