The following is a guest commentary by Henry Yu, senior vice president and Southeast regional director for East West Bank.
Like most economists, I believe that U.S. dollar is here to stay and will continue to be the world’s currency. However, one cannot ignore the rise of importance and acceptability of the Chinese yuan, also called the renminbi or RMB.
The reality is that RMB settlement, whether resulting from trade, investment, M&A, IPO, securities and commodities trading, will continue to gain momentum and acceptance in our global economy. The RMB will become one of the world’s reserve currencies, alongside the U.S. dollar, the euro, the pound sterling and the yen. The question is not if this will occur, but when?
History offers some clues. It took the Japanese yen 17-18 years to become a reserve currency. But the Japanese did not utilize cross-border trade settlement as a key step during the process in 1960s.
The Chinese government, on the contrary, has taken many baby steps throughout the entire process. Starting with trade, it has gradually included bond issuance and RMB-denominated IPOs, allowing foreign central banks to hold RMB as reserves. Because of these and other efforts, it will clearly take less than 17 years for the RMB to become a reserve currency.
In fact, this will likely happen in less than 10 years, thanks to an array of measures that will increase the pool of RMB worldwide:
1. RMB cross-border trade settlement will continue to gain momentum. By 2015 more than 20 percent of China’s trade will be settled in RMB, according to forecasts. This creates depth, liquidity and a wealth of RMB both on shore and off shore.
2. Concurrently, the development of the so-called “Dim Sum Bond” market – issuing RMB-denominated bonds through Hong Kong – paired with commodity and security settlement in RMB, as well as growing debt and capital markets in China, will speed up RMB full convertibility in both trade and capital accounts.
3. Execution of more currency SWAP arrangements (currently with about 10 countries) by China and the rest of the world will increase circulation and liquidity of RMB.
4. Utilization of offshore RMB centers (Hong Kong is to be joined by others such as Singapore, London, Chicago, Frankfurt and New York) will create a huge pool of offshore RMB that are fully tradable and convertible. China’s working with global financial centers allows such offshore RMB to be channeled back to China, and thus will create a one RMB currency for both offshore and onshore.
Will the Yuan Be Set Free?
Of course, all this depends on the Chinese government’s appetite for loosening capital controls and deepening its debt-equity markets. There is evidence that these are starting to occur.
More than 15 months ago, the government announced that Chinese companies are allowed to use their export proceeds kept overseas to invest in the markets outside of China. This partially explains the substantial foreign direct investment flowing into emerging markets and the West from China.
The RMB can also be used for mergers and acquisitions – loan financing involving Chinese companies buying overseas firms – subject to prior approval.
The government is also allowing repatriation of profits, dividend payouts and capital injection in RMB (also subject to approval).
Facts
-Since the inception of RMB Cross Border Trade Settlement Pilot program in July 2009 and through end of 2011, about 9 percent of China’s trade, or about $300 billion, has been settled in RMB
-As expected, the majority of RMB-settled trade transactions are heavily concentrated on China’s imports and exports with Asia, Middle East, South America and other emerging market economies
-Europeans are also increasingly using RMB as a settlement currency
-The first U.S.-China trade transaction settled in RMB was in April 2010
-U.S. importers and exporters are reluctant to use RMB as a settlement currency due to fear and llack of education
-Through 2011, the Dim Sum Bond market in Hong Kong allowed over 30 issuers (Mainland Chinese companies and financial institutions) to issue $13.3 billion in RMB bonds. This market is also open to Chinese subsidiaries of foreign banks and corporations.
Based in Atlanta, Henry Yu is senior vice president and Southeast regional director for East West Bank. He returned in 2011 from a more than three-year stint in Shanghai, where he worked on RMB commercialization issues for Standard Chartered Bank. He can be reached at henry.yu@eastwestbank.com.
