Busy behind the scenes

The internationalisation of China’s currency has gathered pace recently, but the mood in the overseas capital markets has been muted. As more barriers come down, both onshore and offshore investors will need to be ready for new opportunities.

For all the talk of the renminbi’s potential to become a truly international currency within the next five years, there appears to have been little related progress in the capital markets.

A recent attempt to introduce renminbi shares in Singapore fell flat, London-targeted renminbi bond issues have failed to live up to the hype, and the flow of Dim Sum bonds from multinationals has all but dried up.

While the overseas renminbi market may be throwing up fewer landmark deals, however, far more is going on behind the scenes. This focus on creating a stable framework is forcing capital markets bankers to be patient, but promises to offer greater benefits in the long term.

“The RMB does not yet play a large role in international capital market transactions, largely because China’s capital account is not yet open and the currency not yet flexible,” said Louis Kuijs, chief China economist at RBS. “For major international currencies, the bulk of international transactions are capital account transactions. Thus, in this sense the RMB is not yet a major international currency.”

The renminbi, however, is gaining traction in global trade.

Around 16.6% of China’s total trade is now settled in its own currency – a rapid growth since the country’s central bank began promoting renminbi trade settlements in 2008. Hong Kong introduced such a programme in 2010 and now dominates that market, with 89% of renminbi trade settlement going through the SAR in 2012, according to Barclays analysts.

Global payment co-operative SWIFT attributes around 79% of global renminbi payments to Hong Kong and about 5% to China. However, the UK, Singapore and France also appear among the top six for renminbi payments, a sign of the currency’s growing international usage.

“In our view, exchange-rate flexibility and full capital-account opening will – rightly – still take some time,” said Kuijs. “Thus, while we are confident that the RMB is set to become a major international currency, given the importance of China’s economy and the government’s objective, it will take a while.”

However, development, so far, has not always been smooth. After a surge in early interest, renminbi deposits in Hong Kong – which has, by far, the largest offshore pool of renminbi – stopped rising in late 2011 and even declined through most of 2012 as investors revised their expectations for the currency amid fears of slower economic growth in China.

There has been a reversal in decline since September 2012, while renewed expectations of currency appreciation have boosted international interest in the renminbi in recent months. Offshore renminbi deposits rose 10.8% in the first quarter of 2013, faster than the 2% growth for the whole of 2012.

The international expansion continues, with trade volumes growing and more central banks adding the currency to their own foreign-exchange reserves. The Reserve Bank of Australia in April said it would allocate around 5% of the country’s forex reserves to renminbi assets, making the Chinese unit the only Asian currency it holds other than then the yen.

Roadmap emerges

Appreciation and internationalisation, then, go hand in hand. A rising renminbi will certainly attract global investors, while accelerating the currency’s internationalisation also appears to be a priority for China’s central government.

“We believe the PBoC has also shown increasing tolerance of a stronger RMB in order to help promote RMB internationalisation,” said HSBC’s Paul Mackel, head of Asian currency research, and Ju Wang, senior FX strategist, in a mid-April note.

“While we do not think one-way appreciation is the only reason for offshore investors to embrace the RMB as an upcoming trade, investment and reserve currency, a relatively strong and market-oriented currency is likely to facilitate the process of the RMB gaining international traction.”

HSBC has made some of the most aggressive predictions for the renminbi, calling for the currency to become the world’s third-largest trade settlement currency in 2015 and fully convertible within five years.

China’s State Council appeared to bring that ambitious timetable within reach in early May, when it announced that it had instructed several departments to draw up plans for the basic convertibility of the capital account by 2015 and full convertibility by 2020 as part of its 2013 reform agenda.

“We would expect a draft programme, together with reform proposals for six other areas, to be presented for approval to the Third Plenum of the Central Committee of the Party in the autumn. If things progress smoothly, we could see some breakthrough steps from early 2014,” Barclays analysts Yiping Huang, Steven Yang and Jian Chang wrote on May 22.

So far, the gradual pace of liberalisation, however, has limited the appeal of the currency from an investment point of view. As more renminbi is used in trade settlement beyond China’s borders, demand for investment products will grow, but capacity of the overseas renminbi capital markets is far from clear.

Although still growing, the early enthusiasm for Dim Sum bonds has cooled significantly. Slumping offshore demand sent Dim Sum yields almost flat to China’s onshore benchmarks in 2012, giving PRC companies less of an incentive to issue debt overseas. Although the arbitrage opportunity has since reopened, foreign issuers are largely staying away, finding the renminbi a poor alternative to the US dollar. Even companies with extensive Chinese investment plans, such as Caterpillar, a multiple Dim Sum issuer in previous years, have been absent.

Quiet progress

Instead, the bigges issuers of Dim Sum debt this year have been high-yield Chinese property developers, most of which have turned to the offshore renminbi market only after taking money off the table in US dollars. While high-yield bonds add some welcome depth and diversity to the Dim Sum market, large proportions of these high-coupon bonds have gone to private-bank clients, saying little as to the currency’s long-term appeal to global institutional investors.

Progress in other asset classes has been far more disappointing. A recent attempt to float renminbi-denominated shares in Singapore fell flat, and international banks remain either unwilling or unable to commit to big-ticket overseas term loans in the currency. Shallow and short-term derivative markets are still keeping many investors and issuers away.

Behind the scenes, however, much has been accomplished. While only two stocks trade in renminbi on the Stock Exchange of Hong Kong, regulators have formalised the trading support facility, easing liquidity fears among investors in ensuring they will be able to trade between the two currencies whenever they need.

The Hong Kong Monetary Authority has also pledged to introduce this summer a formal interbank rate for the renminbi, dubbed CNH Hibor. Analysts are cautiously optimistic that the benchmark, as well as other measures announced in May, will boost liquidity in the rates and interbank markets.

“The forthcoming launch of CNH Hibor will provide benchmark CNH funding costs and boost developments in the CNH rates market, particularly CNH interest-rate swaps, but until we have more details, it will be difficult to comment specifically,” said Gao Qi, vice president for Asia FX and interest rate strategy at RBS. “The cancellation of the liquidity ratio reflects the regulator’s intention to expand the offshore CNY business further. More CNH liquidity will be available in the interbank market.”

Less than US$5bn of the US$77bn in outbound foreign direct investment from China in 2012 was denominated in renminbi, but cross-border investment flows are also deepening as the mainland opens up.

The first PRC funds focusing on overseas renminbi investments are beginning to emerge, adding to the overseas pool. Yunnan-based Highland Capital Management is aiming to raise Rmb5bn for a fund to invest in South-East Asian companies that sell to China. Sailing Capital Management, run by a unit of the Shanghai Municipal Government, launched a similar fund in 2012.

Bigger quotas

Bigger quotas are expected under the Renminbi Qualified Foreign Institutional Investors (RQFII) scheme, while there is talk that Chinese individual investors may be allowed to access overseas capital markets.

Greater two-way flows may be in China’s interests, too.

“Strict control of cross-border capital flows is also no longer possible, given the increasing openness of China’s economy at large,” the Barclays analysts said. “Financial repression, including interest-rate regulation and capital-account controls, has become a serious drag on economic efficiency and growth. Liberalisation is the best way to facilitate the change required in China’s growth model.”

Opening up, however, brings with it new risks, putting pressure on exchange and interest rates and, potentially, threatening China’s financial stability.

China’s recent move to curb speculative inflows by restricting onshore banks from lending in foreign currencies suggests it is keen to manage the process carefully, releasing its grip on its managed exchange rate only gradually.

For all the uncertainty and volatility along the way, the fundamental driver still exists. China is building its presence in the global capital markets and taking the renminbi with it for the ride.

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