Thinking the unthinkable is something big global companies have been doing quite a lot of these days. There are many reasons why, and that includes Beijing’s summer announcement that it is internationalizing the country’s currency even more by making trade between local and foreign firms far easier, and possibly cheaper, than ever. Though barriers remain, that essentially means companies of all shapes and sizes have more foreign-exchange flexibility in settling cross-border transactions with suppliers, distributors and customers as they use the renminbi (RMB) alongside the U.S. dollar, euro, Japanese yen or other big currencies.
As part of the push by China’s government for a higher global profile for the RMB, enabling it to flow across borders and be exchanged back and forth into other currencies more freely is a phenomenal step forward for many businesses. Corporate and banking experts say companies can now expect a number of benefits, ranging from more accurate and transparent pricing of products and services being traded inside and outside China, fewer transaction costs, and better treasury and risk management generally.
But champagne bottles aren’t popping just yet. It many take a while before large-scale change happens. On a visit to London in September, Zhou Xiaochuan, governor of China’s central bank, put paid to rumors circulating at the time that the currency would become fully convertible by 2015. Many observers don’t expect that to happen until 2030 at the earliest. Until then, companies will be weighing up carefully the pros and cons of embracing the RMB.
Step By Step… By Step
The seeds were sown for the latest phase in 2009 when China’s central government launched a pilot project allowing the currency to be used as a settlement currency in cross-border transactions conducted between five Chinese cities and Hong Kong, Macau and members of the Association of Southeast Asian Nations. Last year, it expanded the program to nearly two-dozen other cities involved in trading anywhere in the world. Then by August this year, the program became nationwide. Today, 67,000 Chinese companies have received the so-called Mainland Designated Enterprise status, permitting them to conduct cross-border transactions using RMB.
Increasing the currency’s private international use for, say, invoicing between companies is the first of three expansion stages that Beijing policy makers have designed for the RMB. Another, closely related, stage involves making the RMB a global investment currency for companies and individuals, allowing the cash they generate in the currency to move onshore and offshore in bank accounts or other financial asset classes.
The third stage — making the RMB a global reserve currency — is arguably the toughest. As Deutsche Bank analysts wrote in a November research paper onthe BRIC currencies, “only the RMB has the potential to become a major, albeit not the dominant, reserve currency by 2030. The [U.S. dollar] will continue to benefit from incumbency, and is therefore unlikely to be displaced as the ‘dominant’ reserve currency,” at around 60% of all reserves today. To achieve that dominant status, however, China willneed to develop “liquid, large and highly rated (ultimately: sovereign) bond markets,” they noted.Currently, China’s government bond market is a “mere” US$1.6 trillion — “though comparable in size to Germany’s, it … is not large enough to absorb even 10% of present global FX reserves.”
According to Gary Liu, professor and deputy director of the financial research center at China Europe International Business School (CEIBS) in Shanghai, China’s capital markets, including its bond market, “are still underdeveloped.” And until that changes, “foreigners will reluctant to hold [RMB],” he says. “We shouldn’t get our hopes up too high,” adding that despite China’s strong financial performance today, much uncertainty lies ahead. “If the future is unclear, how can a currency internationalize?” he asks.
Still, Beijing officials “are hitting the accelerator,” says Steve Kelly, head of global RMB at New Zealand bank ANZ. ”In 2009, no one was quite sure what to think, but the pace of change in the last six months has been so substantial that it is hard to doubt that the RMB will eventually be one of the reserve currencies of the world.… For China, “moving capital in and out of China is only the first step.”
The result of the summer’s policy changes is a dramatic leap in the amount of RMB-based transactions worldwide. Analysts at the Society for Worldwide Interbank Financial Telecommunication (SWIFT), which provides secure messaging between financial institutions, started tracking the number of RMB payments among its users in October 2010 and reported an increase of more than 1,000% over the first 12 months of their monitoring, scooting the RMB up the ranks of currencies used for global payments from 35th place to 15th place. “In terms of absolute volumes, it is still small,” says Wim Raymaekers, head of banking market at SWIFT in Belgium. “But it is growing at a fast pace.”
In September, more than 1,000 financial institutions in 83 countries conducting transactions in RMB with SWIFT, up from 913 in 73 countries just three months earlier. Hong Kong is the center of activity for RMB transactions, primarily because all RMB clearing is still done by a People’s Bank of China unit there, says Raymaekers. However, Taiwan, Singapore and London are vying for more of the action.
And while, volumes are said to be declining, the value of payments sent and received through SWIFT’s system by countries other than China and Hong Kong — including Russia, Indonesia, and the Philippines — has increased over recent months, to 14%. According to various reports, firms based in emerging markets that are not already trading in U.S. dollars or euros stand to gain the most by transacting in RMB.
Jumping on the Bandwagon
For Chinese companies, using RMB in trade settlements is attractive indeed. “One theme is clear: The majority of cross-border renminbi flow is coming from payments made by companies in China to international suppliers for imports,” noted Bruce Alter, head of trade and supply chain in China for HSBC in a recent report.
This summer, a survey of Mainland companies by HSBC China found that 78% of the respondents that hadn’t yet used RMB to settle cross-border trade said they were planning to or considering it. In the past, the decision might not have been as clear-cut — China’s exporters reaped the benefits of Beijing’s policy of maintaining an artificially low RMB and building up stashes of reserves in stronger currencies. But now with the RMB’s appreciation — it has risen 8% against the dollar since 2008 — being able to invoice and carry out other transactions more globally with their home currency is attractive.
Also, Chinese companies have greater flexibility in managing their foreign exchange risk. In the past, Chinese exporters, for example, have tended to price any exchange rate risk into the products and services they sell, according to ANZ’s Kelly. With restrictions lifted on global access to the RMB, they can offload some or all of that risk to customers, and so may also be more willing to negotiate prices. “If the overseas customer is going to denominate in RMB, that eliminates that risk for the Chinese customer,” he says. “So that premium should disappear.”
As for non-Chinese multinationals, the news is also good. Outside China, companies can hold RMB in the expectation that the currency will appreciate or invest it in the small, but growing, number of financial products that China offers.
Whether an international company chooses to transact in a more easily convertible currency than the RMB “depends on the balance of power,” says Raymaekers. “If you are a huge retailer in the U.S. and you’re importing toys, there are a lot of suppliers out there wanting your business. At the end of the day, those payments are in U.S. dollars and you will probably continue in U.S. dollars in the near future.”
Since 2009, for example, foreign and local entities have been allowed to issue so-called RMB-denominated “dim sum” bonds — as long as they have an RMB account to receive the proceeds. In the first 10 months of 2011, RMB 160 billion (US$25 billion) of debt was issued on this market, compared with RMB 35.7 billion in all of 2010. McDonald’s, Caterpillar and Volkswagen have issued RMB-denominated bonds to fund projects in mainland China, primarily attracted by low interest rates. Caterpillar, for example, is paying 1.35% on its two-year bond issue launched in July. The RMB loan rate at banks in China is set much higher, around 6%.
All told, the treasury departments of non-Chinese multinationals with operations on the Mainland have much more flexibility with the cash they generate. But it is still complex. According to a July article in CFO magazine, “in reality, there are now two forms of RMB that trade at slightly different exchange rates.” Non-Chinese companies can accumulate the more freely tradable version of the currency — informally called offshore RMB — in bank accounts newly available in Hong Kong and elsewhere. “Using those accounts, they can pay Chinese suppliers (and trading partners in some other Asian countries) and accept payments from their Chinese customers,” noted the article. Meanwhile, exchanging RMB into other currencies is now permitted, with limits.
‘Controls Are Still There’
Both Chinese and non-Chinese firms need to consider a number of factors before changing their RMB strategies. “Treasurers need to keep in mind that there is still higher risk of convertibility and transferability than with the U.S. dollar,” Philippe Jaccard, head of global liquidity and investments in Asia-Pacific for Citi told CFO.
“[The renminbi] is a trade currency. You can’t use it to repatriate profits,” Bruce Robertson, assistant treasurer at Westlake Chemical, a Houston-based chemicals company, reminded delegates at an Association for Financial Professionals conference in November. He added that, while China has loosened restrictions on the ability of Chinese units of multinationals to move money from the Mainland to Hong Kong and back, the Chinese government is reluctant to allow companies to transfer profits made in China to parent companies in other countries.
Because of the challenges companies still face in bringing money in and out of China, a corporate treasurer of a U.S. multinational with a large base in the Mainland said his company keeps separate pools of capital for its Chinese and global operations. “The exchange controls are still there,” he says.
In addition, day-to-day practicalities may also prevail — for example, companies need to make time-consuming or costly treasury management policy and technical changes to accommodate a new currency. “The question is: Why would you do it? There has to be significant benefit to go in and change your internal systems,” says the treasurer. “Technically, changing currencies or trading in new currencies is very easy. But behind it, you have a bunch of contracts in a particular currency, and within companies you have IT systems set up to bill in certain currencies.”
So what then is the biggest incentive for change for mulinationals like his? “Obviously there’s a certain amount of official encouragement,” he says. But business is business after all, and “what’s going to drive things is people’s economic interest.”