China’s Currency Gains Global Reach

Renminbi expanding as trade currency, but reserve status still far off
November 19, 2014 Updated: November 20, 2014

China is tirelessly working to promote the use of its currency, the renminbi, across the globe. It is making progress, even in North America. 

Earlier this month Canadian Prime Minister Stephen Harper brokered a deal for his country to become the first trading centre for renminbi (also known as yuan) in North America. 

During a visit by Chinese Communist Party head Xi Jinping to Australia, Sydney announced on Nov. 17 that it would become the first Australian renminbi trading hub. And Frankfurt, designated as first euro-area renminbi hub back on March 28, cleared its first transactions in the Chinese currency earlier this week, according to a report from Bloomberg.

China has made a lot of progress internationalizing the renminbi since Hong Kong became the first city outside of China where local banks could accept renminbi deposits in 2004.

These renminbi trading hubs will facilitate more bilateral trade between China and its partners. More bilateral trade and trading hubs in time zones of major international financial markets are necessary steps for the renminbi to become a reserve currency. 

It is clear the Chinese authorities desire decreasing reliance on the U.S. dollar as the world’s reserve currency. By internationalizing their own currency, gaining wider acceptance in central bank reserve portfolios, China could then borrow more from international investors to fund public deficits.

Global Reach

Joachim Nagel, a board member at Germany’s central bank, the Bundesbank, said in a speech in Frankfurt on Nov. 17, “It is only a matter of time before the renminbi becomes an international reserve currency,” as reported by Bloomberg. 

According to the Bank of International Settlements’ triennial survey of global foreign exchange markets, the renminbi had less than 0.1 percent share (ranking 35th) of foreign exchange market turnover in 2001. As of 2013, it commanded a share of 2.2 percent (ranking ninth). 

While that may not seem like much, in 2013, the renminbi surpassed the euro as the second most used currency in trade finance after the U.S. dollar.

Capital Account

The benefits for China’s trading partners are clear. For foreign firms doing business in China, the ability to avoid unnecessary transaction costs of going through the U.S. dollar and gaining more favorable credit terms will spur further trade. The trading hub will facilitate development of the range of financial products and services in the Chinese currency, which additionally aids the ability of foreign firms to do business in China.

Chinese regulators have granted Canadian and Australian financial institutions a quota of 50 billion renminbi through their Renminbi Qualified Foreign Institutional Investor (RQFII) program. It allows investors to purchase renminbi-denominated bonds or equities in China’s capital markets. 

The steps taken also allow Chinese money to move out of China and migrate abroad, diversifying away from, for example, domestic real estate markets.

There is no question about China’s position as a major world trading powerhouse. It is the second largest economy in the world and the world’s biggest exporter. What is striking is its limited integration into global capital markets, which was part and parcel of the Chinese regime’s reform policies. 

However, truly international currencies are usually associated with large, liquid, and open financial markets. While China is expanding the reach of the renminbi in terms of a trading currency, it lags far behind Western markets in terms of liquidity, rule of law, and regulation. 

If it manages to address these issues, the renminbi could really become a world reserve currency. If not, it will remain what it is now: a currency used for settling trades.

Follow Rahul on Twitter @RV_ETBiz

Follow Rahul on Twitter: @RV_ETBiz