CHINA, THE RENMINBI AND THE WORLD

A NEW TRADE CURRENCY

These developments are providing a mirror to activities offshore, where the use of renminbi as a payment currency is rising rapidly. According to SWIFT and its monthly RMB Tracker, the renminbi as a global payment currency rose recently to seventh position, from 35th in 2010. Although most trade transactions with China from overseas are still denominated in dollars, approximately 25% of all of China’s overseas transactions are now conducted in renminbi. An accelerating number of companies that transact directly with clients in China are being asked by counterparties to invoice and pay in renminbi.

While international companies are being asked to shoulder the exchange rate risk, they also often gain advantages, such as being able to negotiate better trade terms and gain discounts on goods and services, according to Martin Keller, European head of interest, currency and liquidity management at Germany’s Commerzbank. Keller says that a rising number of Mittelsand companies in Germany have been switching over to accepting renminbi as a trade finance currency.

Use of renminbi offshore has now become significant enough that parallel developments can sometimes lead to counterintuitive outcomes. In November 2014, Hong Kong and Shanghai established a program called Stock Connect that linked the cities’ two financial markets for the first time. The cross-border investment channel has allowed investors in Hong Kong and the mainland to trade a specified range of listed stocks in each others’ markets through their respective local securities companies. The pilot program is expected to lead to others: On January 5, Chinese premier Li Keqiang said that he expected to see another pilot between Shenzhen and Hong Kong introduced, although he did not specify a time frame.

The Hong Kong‒Shanghai Stock Connect had a lukewarm start after considerable hype, but then Hong Kong investors in Shanghai stocks began to catch on. In the first two weeks of operation, Shanghai-bound investment from Hong Kong amounted to approximately Rmb50 billion ($8.1 billion), according to Thomson Reuters’ CNH Tracker newsletter. However, investments from Shanghai to Hong Kong amounted to only one-tenth of this amount.

The trend has persisted. The introduction of the new pilot, while surely boosting the internationalization of the renminbi, has had the effect of draining offshore renminbi deposits in Hong Kong banks, putting a further damper on offshore renminbi lending from Hong Kong. According to Nathan Chow, an interest-rate strategy analyst at DBS Bank in Hong Kong, outstanding renminbi loans of Hong Kong banks totaled only Rmb123 billion as of the middle of last year, about one-sixth of the so-called dim sum bond market, or the market for offshore renminbi bond issuances from Hong Kong.

The attraction of the dim sum bond market has continued to drain renminbi offshore deposits, as the market has had its strongest year yet. As of the third week in December, dim sum bond issuance had grown by 74% over 2013 volumes to reach Rmb324 billion. One reason for the growth is that dim sum bonds began offering higher returns than other competing global credits in 2014. This was a result of volatility in China’s markets, prompting issuers to offer higher interest rates to attract investors. The trend is expected to continue this year, with companies offering even higher yields as volatility persists.

But this hardly means that offshore renminbi lending will be on the wane for long. DBS’s Chow points to recent policy changes in China whose intent is to achieve a currency regime “less biased towards one-way appreciation.” He sees banks eventually structuring more products in renminbi. “As more global investors use such products to participate in markets and hedge risks, this will be another important step towards internationalizing the renminbi,” he says.