Aiming for economic clout: China's renminbi-isation
How Beijing can emulate US, German investment returns
by David Marsh in Singapore
Mon 14 Jul 2014
Senior US monetary officials, both in office and in retirement, habitually muse about America’s celebrated ‘exorbitant privilege’ – the US ability to earn far more on its foreign assets than it pays out on its liabilities, a consequence of the reserve currency status of the dollar. The general view from senior Americans is that the benefits given by the celebrated privilege are exaggerated and the dollar’s international status is more trouble than it’s worth. Well, that’s not the way China sees it.
One of the reasons behind the currency liberalisation drive of the Beijing authorities is to carry out a large-scale switch in the country’s asset management procedures to enable far more international trading and investment transactions in the renminbi rather than the dollar. This includes allowing the renminbi to be much more extensively used in pricing commodities than has been the case for the present No. 2 currency, the euro. One of the big themes for international banks and financial companies in the next 10 years will be a progressive ‘renminbi-isation’ of internationally-traded investments – whether in stocks, bonds or privately-traded vehicles. China is attempting to shift more of its foreign assets into investments held outside its giant, mainly dollar-denominated foreign exchange reserves – and move to instruments valued in its own currency.
One further step towards greater currency flexibility and enhanced use for cross-border transactions came last week after talks in Beijing between the US and Chinese governments under which Beijing pledged to ‘reduce foreign exchange intervention as conditions permit’. The two sides will refrain from competitive devaluations and extend the number of areas of their domestic industries open to reciprocal foreign investment. Although the strategic relationship between the world’s two foremost economies remains bedevilled by mutual suspicions about political and military powerplay in Asia, China plainly regards economic liberalisation – vis-a-vis the US, Europe and important Asian economies – as an important tool to increase its own international financial clout.
The Chinese authorities have made clear that liberalisation will be gradualist and will not lead to a laissez-faire ‘bonfire of controls’. China is making categorical efforts to learn from other countries’ experience. The post-war eurodollar market in offshore dollars in Europe was built up largely because domestic US limits on interest rates paid on deposits encouraged banks to offer higher deposit rates for dollars held in European markets – and also because institutions from the Soviet Union and other members of the eastern bloc wished to maintain dollar holdings beyond the immediate jurisdiction of the US Treasury. Renminbi trading and investment activities in Europe, by contrast, will be less driven by opportunistic market-building and much more so via a state-inspired attempt to raise the market share of renmimbi operations and challenge the dollar’s supremacy.
China sees London as a premier hub for European renminbi operations, with important activities connected to the euro area taking place in Frankfurt, Paris and Luxembourg. The authorities in Germany are keen to encourage a Frankfurt-London partnership in renminbi under which the UK capital takes over the main responsibility for global transactions in the Chinese currency while the leading financial centre on the European continent becomes the principal gateway for euro-based, industry-focused renminbi deals.
All this may be easier said than done. One significant incentive for the Chinese authorities to speed renminbi-isation is China’s lamentable track record in making returns from its large net foreign assets. There are signs that China takes this seriously. A research paper from the Basel-based central bankers’ bank, the Bank for International Settlements (BIS), in September 2013 (Working Paper No. 424, Global and euro imbalances: China and Germany, by Guonan Ma and Robert N. McCauley) came up with intriguing reasons why China and Germany, respectively the world’s No. 2 and No. 3 creditor nations (Japan is No.1), have recorded entirely different performances in their overall foreign investments over the past 15 years.
At the end of the 1990s, both countries had rather slender net foreign assets, with China in negative territory and Germany close to zero. A string of large-scale current account surpluses in the first decade of the 2000s changed all that, with China advancing to a peak of more than 30% of GDP in net foreign assets (excess of assets over liabilities) by 2007, before retreating to around 24% more recently following the fall in the country’s current account surplus. Germany, benefiting from the enhanced competitiveness of export-orientated companies after the entry of the euro in 1999, has extended its net foreign assets to nearly 40% of GDP in recent years.
Although Germany’s net assets have been on average lower than China’s, it has made consistent annual returns since 2005 of between 5 and 6% of its net international asset position, according to the BIS paper, while China has turned in regular annual losses averaging around 3 to 4% of its asset position since 2008.
The BIS experts ascribe this to two overriding reasons. First, the official sector – both government entities and the central bank – accounts for a much greater percentage of internationally-held assets in China than in Germany. This is a product of overwhelming state control in China which is only gradually – and with great caveats – being relaxed. Second, and more importantly, China’s net investments have been substantially geared to other countries’ (mainly the US) debt instruments. Meanwhile Germany has been orientated far more towards portfolio investments in equities and in direct investments, often denominated in its own currency, as the euro since 1999 has been both a domestic and an international currency.
The Chinese authorities draw two important lessons from these episodes. One is to try to economise on the state’s foreign reserves, as Germany has done consistently since the early 2000s by deliberately lowering the Bundesbank’s standard foreign reserves position. Here, China has shown very little progress, as the continued advance of the People’s Bank of China’s (PBoC) reserve holdings, now close to $4tn, demonstrates. The second has been to try to shift the country’s overall foreign portfolio into a greater proportion of equities – seen through diversification by both the State Administration of Foreign Exchange and by the PBoC itself – and to extend renminbi-isation.
There is a potentially explosive political contradiction between state control on the one hand and, on the other, allowing a diverse range of non-state sector Chinese enterprises and investors to build up assets overseas in a much wider variety of vehicles. How the Chinese authorities resolve this dilemma will be a major conundrum reaching into many facets of foreign economic and investment policy – likely to keep Beijing-watchers occupied for many years.
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