Year Of The Renminbi: Is Full Convertibility Around The Corner?

On many fronts, the renminbi’s relevance to global finance is advancing fast. The pace can seem breathtaking. Offshore transactions are on the rise. Companies with substantial sales in China now use renminbi for offshore acquisitions, to manage global supply chain relationships and to pay employees. ShanghaiHong Kong Stock Connect—a platform linking the two equity markets—opened late last year. In April regulators allowed mutual funds in China to invest via the program into Hong Kong for the first time, sparking a rally in Asian stock markets. China’s financial infrastructure to connect to Asia is being built, and its funding will be partly renminbi-denominated. Plus, the International Monetary Fund is mulling giving the renminbi reserve currency status. Everywhere you look, the renminbi is gaining traction.

But there are still major steps that must be taken by policymakers in Beijing before the currency reaches full convertibility. And when those steps will be taken remains to be seen.

The IMF decision on reserve currency status, if positive, will be a crucial milestone in the international development of the currency, giving the renminbi the cachet to sit beside the US dollar and the euro on the global stage. At issue is the inclusion of the renminbi in the Fund’s “special drawing rights” basket. SDRs form the IMF’s virtual currency, created in 1969 to complement existing reserves of member countries. Granting of SDR status would “send a signal to both corporates and the market that liberalization of the currency has come a long way and build confidence in China’s policy on opening of the capital account,” says Evan Goldstein, Hong Kongbased global head of renminbi solutions at Deutsche Bank.

Goldstein, appointed to this newly created position last year, is among a growing number of renminbi gurus at big banks—another sign of the attention that global financial institutions are paying to the currency’s development. HSBC’s Vina Cheung is global head of renminbi internationalization, a Hong Kongbased job created two years ago. Likewise, Julien Martin heads the renminbi competence center at BNP Paribas, a post created last year. The list goes on. These posts reflect banks’ strategies to consolidate renminbi services into coherent offerings.

The impetus is coming, in part, from clients. “Multinationals are now seeing the importance of staying on top of renminbi developments,” says Cheung. “From a corporate standpoint, they’re already ticking a lot of the boxes. Do they invest offshore in renminbi? Yes. Do they inject funds into China in renminbi? Yes. Do they hedge in renminbi? Yes. They’re looking for a way to establish best practice across all activities—and to stay on top of a fast-moving situation.”

How fast-moving? Carmen Ling, global head of renminbi solutions, corporate and institutional clients at Standard Chartered, likes to point to the growing amount of renminbi cross-border trades outside of China. Ling cites a recent trade from a European company in offshore renminbi—also known as CNH—paying a supplier in Africa. The African supplier was happy to be paid in yuan (yuan renminbi, the denomination), because it could remit funds to its suppliers back in China. These transactions are becoming the bread-and-butter of global financial institutions. “Banks need to play a role in matchmaking these opportunities,” Ling notes.

With internationalization comes responsibility. The acceleration of offshore use of the currency aligns with China’s increasing economic and political clout. The government is seeking inclusion in the SDR basket concurrently with its launch of the Asian Infrastructure Investment Bank (AIIB). The bank, seen as a rival to the US-dominated World Bank, will finance projects like the building of roads, railways and airports. It will be headquartered in Beijing and start with a pot of $50 billion, with a goal of reaching $100 billion.

So far, 57 nations have signed on as founding members of the fund with China—the US and Japan are conspicuously absent. The move handily addresses a criticism sometimes lobbed at China’s leaders that the government has not stepped onto the stage of world economic leadership at a pace commensurate with its phenomenal growth. The Washington-based IMF is eyeing AIIB developments from the sidelines. Shaun Roache, the IMF resident representative for Hong Kong, reiterated the IMF’s stance at a Hong Kong conference recently, saying that it expects the new development bank will complement rather than compete with the activities of existing multilateral lenders.

The AIIB will almost certainly boost the ecosystem of renminbi payments. The creation of the bank is also calculated to edge the IMF toward granting SDR status to the renminbi. When IMF members debate the issue later this year, it will be hard to say no.

One reason is that a review of membership to the SDR basket is done only every five years, making the IMF’s decision particularly delicate. Should it refuse admittance now, where will the renminbi be in five year’s time? China is comfortably in place as the world’s second-largest economy, having edged out Japan in 2010. In terms of purchasing power parity, or PPP, a technique used to determine the relative value of currencies, China surpassed the US to become the world’s biggest economy in October 2014, according to the IMF’s reckoning. Although China’s economy is slowing, the government aims to sustain average annual GDP expansion of 7% over the next five years. This will ensure steady growth in cross-border yuan usage.

Deutsche Bank’s Goldstein refers to the renminbi’s “de jure, versus de facto” status as a reserve currency. Because of China’s status as the world’s biggest trading nation, governments with big exposure to Chinese imports are covering their risk by building renminbi reserves. Jukka Pihlman, managing director and head of central banks and sovereign wealth funds at Standard Chartered, notes, “There are some countries in Africa where 30%, even 40%, of imports are coming from China. So it just makes a perfect risk-management policy, from the asset-liability perspective, to hold renminbi. There are many other reasons why central banks would invest, but that trade linkage is very clear: China is the largest exporter in the world.”

Multinational embrace of the yuan is a given. A recent survey by law firm Allen & Overy asked multinationals outside of China about their projected use of the currency. Some 50% of executive respondents predicted it would double in five years.

The respondents already showed a high rate of adoption of the renminbi across a broad variety of uses. Forty-five percent of the respondents had used it for cross-border intracompany lending over the past 12 months. But only 21% had done so in the 12 months preceding that. Just under 50% said they had channeled renminbi offshore from China without converting to other currencies over the past 12 months, compared with 21% who said they had been doing this for a longer period. About 49% said they were using renminbi to fund acquisitions. Less than 20% said they had been doing so for longer than the past 12 months.

Five years is clearly too long for the IMF to wait. The pace makes it likely the IMF will give the nod this year—but it is not a certainty. The IMF’s Roache says that, in the case of the renminbi’s internationalization, “the board has cut themselves an awful lot of slack. If they think that a review within five years is warranted by changing international monetary arrangements, then that review will be on the table,” he says.

Standard Chartered’s Pihlman concurs but expresses reservations. “There’s been a lot of conversation [among global and multilateral bankers] about the timing. ‘Why don’t we postpone this current review, and arrange another review in one or two years?’ The board does have that leeway. But I think it would be ill-advised.” He points out that the IMF has been promoting the use of the SDR as an alternative to reliance on the US dollar and is in the midst of a program to expand its use by central banks as a reserve currency. “If you now add an additional uncertainty about the timing of the review, that really is hampering the prospects of the SDR itself,” he adds.

Adding the renminbi to the SDR basket now could have an extra benefit for the currency. “Maybe inclusion of the renminbi in the SDR could make the SDR more usable, and at the same time [the IMF could] use this momentum to … help the SDR develop into a more meaningful instrument,” Pihlman says.

Indications are growing that the decision will be positive. The Wall Street Journal reported on May 5 that the IMF is close to making an official reassessment of the renminbi that would declare it a fair-value currency—i.e. not undervalued, as the US and others argue. The new view would help smooth the way to reserve currency status.