The Belt and Road (B&R) may be only five years old in name, but many of the forces foundational to the initiative had been in motion for years before it was announced in 2013.
Nearly two decades ago, the Chinese government began encouraging state-owned firms to invest overseas with its ‘Going Out’ policy. The goal: internationalisation. That drive also became central to the B&R strategy which aims to help the country “integrate itself deeper into the world economic system.”
A key part of this integration has been the internationalisation of the renminbi (RMB). China’s efforts here formally began in 2009, when it made the first pool of offshore currency available to domestic companies. The native benefits are somewhat obvious: reduced exchange-rate risks for exporters and importers and support in limiting risks to Chinese trade from supply shocks to the US dollar (as was the case during the global financial crisis).
The international economy also stands to benefit however; renminbi internationalisation provides broader access to offshore renminbi capital markets, which can reduce borrowing costs. Indeed, interest rates in the offshore renminbi bond market based largely in Hong Kong (also known as the ‘dim-sum market’) are typically lower than onshore Chinese markets. And for international companies operating in China, using the renminbi reduces currency risks and can deliver better pricing.
To be sure, there are also disadvantages. Renminbi internationalisation could complicate the central bank’s monetary policy, making it difficult to sustain free capital movement, exchange rate stability and independent monetary policy. Specifically, it would broaden the scope for residents and non-residents to buy and sell domestic currency instruments, which would limit the central bank’s ability to influence domestic interest rates and the money supply through open market operations. Additionally, if the renminbi becomes a reserve currency, the central bank would bear more responsibility for the rest of the world as the macroeconomic policies of reserve-currency-issuing countries often have significant spill-over effects. This could reduce its independence. Internationalisation also stands to increase the probability of asset bubbles and financial instability if the purchase of renminbi-denominated assets becomes more liberalised
Regardless, with renminbi internationalisation and B&R continuing to be high priorities for China, these initiatives will be intertwined for decades to come. But can B&R ultimately strengthen the renminbi’s role in the global economy? And what are the potential benefits for companies doing business along B&R corridors? Much of the answer lies in understanding the success of internationalisation to date.
Internationalisation: A Timeline
RMB Report Card
China has so far taken the road less-travelled for its currency internationalisation, trying to develop an offshore renminbi market while maintaining strict capital controls and tightly regulating financial markets.
Renminbi internationalisation seemed to take off between 2010 and 2015. Import payments exceeded renminbi export payments, creating a currency outflow that saw offshore renminbi deposits increase from next-to-nil to more than USD300 billion by 2015. Market expectations for a stronger renminbi drove these flows, which pushed offshore renminbi valuations to a premium, accelerating the currency’s internationalisation.
Internationalisation hit a roadblock between 2015 and 2017 as the People’s Bank of China (PBOC) loosened its role in setting the currency. Renminbi payments for imports fell, while market expectations that the renminbi would depreciate grew. The value of offshore renminbi dropped, the flow of currency moved back onshore, and the stock of offshore renminbi deposits halved in value. Capital controls and the financial deleveraging policy also assumed precedence over internationalisation, restricting the flow of capital into overseas investments.
This setback suggested that the internationalisation process was still heavily determined by both government policy and market expectations of the renminbi’s value.
“When the renminbi was expected to depreciate, renminbi internationalisation also became more difficult to support as a policy,” the Reserve Bank of Australia noted in a 2018 report. “From mid-2014 to the end of 2016, the renminbi depreciated by 10 per cent against the US dollar, private capital outflows were around USD1 trillion and active PBOC reserve sales to support the value of the currency were around USD0.8 trillion.”
Slow and Steady Influence
Though the renminbi accounts for only 1 per cent of allocated foreign-exchange reserves around the world (compared with 63 per cent for the dollar) and about 2 per cent of global payments, its reach has been growing.
Approximately 60 countries hold renminbi reserves, and PBOC has signed bilateral currency-swap agreements with 32 countries, intended to support trade and investment and increase the use of the renminbi internationally. The renminbi’s weighting in Asia’s regional currency baskets has also steadily increased since 2008 (see table ‘The Rise of the RMB in Asia’).
However, with capital controls in place, and no clear timeline set for full renminbi convertibility, there seem to be no obvious triggers to propel further growth of the currency in international trade – except the B&R initiative.
B&R Meets the RMB
Currency internationalisation is driven by trade and outward direct investment. For the renminbi, the B&R’s central role in China’s foreign policy will likely buttress that process. Policy banks and China-led multilateral institutions supporting B&R projects and are more likely to give funding priority to projects under its umbrella.
Ultimately, as long as trade continues to thrive along the B&R, money is likely to flow. And there is growing recognition that using renminbi for B&R projects helps to accelerate construction and act as a safeguard against financial risk.
As intraregional trade between Asian nations and China (see table ‘The Rise of the RMB in Asia’) grows, it makes increasing sense to conduct that trade in renminbi. The more that happens, the more local currency exchange rates will track the renminbi. In fact, many currencies in countries along B&R routes have already begun to show a closer correlation to the renminbi, particularly in Asia.
Pakistan, one of the nations most heavily involved in the B&R initiative to date, became one of the earliest adopters of renminbi-based trade. After two currency swaps in 2012 and 2017, Pakistan’s central bank in 2018 allowed renminbi to be used for bilateral trade and investment. According to the official ‘CPEC Portal’ information service, this is paving the way for renminbi to replace the dollar in the USD50 billion China-Pakistan Economic Corridor (CPEC).
The renminbi’s emergence as the dominant regional Asian currency may not be far off, as long as China continues opening its capital account, allows a more flexible exchange rate, and the pace of B&R trade holds steady.
That said, Chinese authorities will need to take key steps for the renminbi to become a more attractive currency for international trade, according to a Bloomberg Markets report:
- Make it easier for foreigners to buy Chinese bonds
- Relax restrictions on the amount of renminbi loans onshore banks can extend to overseas financial institutions and corporates, thereby boosting the currency’s liquidity offshore
- Continue to increase quotas under programmes that allow onshore investors to buy overseas assets under capital account
- Start a stock-trading link between Shanghai and London
For international companies operating in B&R countries, developments in China’s financial industry could make renminbi usage considerably more attractive. China has pledged to allow majority foreign ownership in its banking, securities and insurance sectors by the end of 2018, and to ease restrictions on the business scope of foreign financial institutions and in areas related to Sino-foreign financial market cooperation.
This foreshadows a not-too-distant future where renminbi could be used to pay foreign companies on B&R projects which invest their proceeds into Shanghai-based renminbi accounts; or where international financial institutions structure B&R project financing in renminbi and funnel payments to their Shanghai operations – where they are invested in renminbi assets, or converted into euro, dollars or yen.
In other words, the renminbi has the potential to become a truly internationalised currency in the not too distant future.
This article was also published on Bloomberg.com.