Focus: Renminbi Swap Network - Trade ties fuel renminbi's appeal
by Danae Kyriakopoulou, Ben Robinson
The growing use of renminbi in international financial transactions over the last eight years has made access to the currency an increasingly important consideration for banks and companies globally. A total of 36 central banks have signed currency swap agreements with China since the end of 2008, totalling Rmb3.3tn (around $500bn), although some of these have expired.
This reflects China’s growing economic influence. Starting off as one of the world’s poorest economies, it has followed an unprecedented growth path and is now on course to become the world’s largest. As a result, it has assumed a prominent role in global capital and commodity markets. As the map below shows, China is now the largest or second-largest trading partner for most of the world’s economies. This creates important incentives for China’s trade partners to hold greater amounts of renminbi in their foreign reserves. Mitigating exchange rate risks and reducing trade costs and transaction times are important considerations, as are ready access to renminbi liquidity and the ability to withstand balance of payments pressures.
With diminishing returns on domestic investment forcing China to look abroad, the country has become an important source of funding for both developed and emerging economies. Access to renminbi liquidity is becoming a vital component of financial stability. In terms of the renminbi’s use in payments, however, China still punches below its economic weight. Although the currency’s importance has risen over the past decade, it is still only the fifth most used in payments, making up just 2% of global payments. But even where trade is conducted predominantly in dollars or euros, holding renminbi can be useful for hedging currency risks and achieving reserve diversification.
Impressive expansion of China’s economy
According to partial data from the IMF, 38 countries held renminbi in their official reserves at the end of 2014. The amounts represented 1.1% of total official reserves, equal to around $75bn. In a live poll held at the Asian Development Bank 2016 Asian Regional Forum on investment management of foreign exchange reserves in November, 46% of representatives from global public investors expected 1% to 5% of their reserves to be held in renminbi by the end of 2018, with a further 17% expecting the share to be between 5% and 10%. Although China’s economic performance has weakened over the past two years, in absolute terms the economy has expanded at an impressive rate and the global share of reserves held in renminbi is likely to be higher now. The IMF will release the first Cofer data with renminbi as a separate currency in March 2017.
The opening up of renminbi-denominated investment options for foreigners has continued since the IMF’s last report on renminbi holdings, further boosting the currency’s international use. Qualified foreign institutional investor and renminbi-qualified institutional investor status has been granted to more countries during 2015-16, while the People’s Bank of China’s swap network has been expanded to eight new countries since end-2014.
Euro uncertainty holds back reserve use
Meanwhile, political and economic uncertainty has continued for the euro, the second largest reserve currency behind the dollar. This has weakened the currency’s appeal as a reserve asset, one of the factors, along with lower valuation, reducing its share of total official reserves from 28% in mid-2009 to around 20% in mid-2016.
The euro’s challenges are expected to persist given a lack of progress with necessary reforms to Europe’s monetary architecture. Elsewhere, the UK vote to leave the European Union is putting pressure on sterling, while a victory for Donald Trump in the US presidential election could set the dollar on a similar path. This sets the stage for a continued rise in the renminbi globally.
Majority of renminbi reserves held in Asia Pacific
While a country-by-country breakdown of renminbi reserve holdings is not available, the large amount of trade between Asian economies and China suggests that most renminbi reserves are held in the region. Asia Pacific accounts for 47% of all trade with China, of which 45% is denominated in renminbi.
This close relationship is further reflected in the prominence of Asia in renminbi swap agreements. The Hong Kong Monetary Authority, Bank of Korea and Monetary Authority of Singapore have swap agreements of Rmb400bn, Rmb360bn and Rmb300bn respectively. Hong Kong’s particularly large swap size reflects the territory’s role as the base for offshore renminbi activity. This allows the onshore rate to remain subject to capital controls, while providing international liquidity to facilitate offshore renminbi activities. The European Central Bank has a further Rmb350bn agreement (renewed in September 2016 for three years). This reflects Europe’s position as the second largest renminbi payments area, with 31% of its trade with China denominated in renminbi.
The entry of the renminbi into the IMF’s special drawing right on 1 October allows central banks to exchange SDR holdings for renminbi liquidity, cementing the currency’s role as an official reserve asset. However, the extent to which countries use SDR in this way will depend on the amount of trade and investment they conduct with China. Resort to this mechanism will probably be low in the next few years, given the dollar’s still dominant role in international transactions and the relatively small amount of renminbi activities.
The renminbi’s international role is rapidly expanding, as evidenced by the increasingly sophisticated use of the currency in international transactions. As well as being used to settle trade in goods between China and some of its partners, and direct investment into China, foreign access to Chinese A-shares and China’s corporate and sovereign bond markets have increased the options for international investors.
Nevertheless, confidence among international investors in China’s stock and bond markets remains weak, and has suffered periodic setbacks due to periods of high volatility, notably in mid-2015 and the start of 2016. Although fears over a hard landing for China’s economy appear to have abated for now, financial market participants remain wary of Chinese policy-makers prioritising growth over reforms and credit-fuelled expansionary policies to stimulate the economy.
The latest quarterly report by the Bank for International Settlements warned that China’s credit to GDP gap, a key early warning indicator for credit vulnerability, had reached dangerously high levels. At 30.1, the gap is the highest to date and more than double that of Canada, the second-highest score for a country examined by the BIS. Corporate indebtedness is seen as a big risk. China’s corporate debt stock stands at around $18tn, equivalent to 170% of GDP.
Short-term risks for China’s economy
To address these concerns, in October the Chinese authorities outlined a range of measures, including encouraging mergers and acquisitions, bankruptcies, debt-to-equity swaps and debt securitisation. But even if successful, these measures will create short-term risks for China’s economy, with repercussions for the renminbi. China has $3.2tn in foreign reserves, but these can be depleted quickly if the currency came under pressure, for example if fears grew of a hard landing.
Despite these potential problems, progress on expanding the infrastructure for the renminbi’s internationalisation has continued unabated. The rapid expansion of renminbi trading hubs in Asia, Europe and the US has been facilitated by the growth in PBoC-designated clearing banks in these regions.
The renminbi is becoming increasingly important in international pricing too. To avoid exchange rate risks and to protect the Chinese economy from shocks in commodity-exporting regions, Beijing is seeking to expand the pricing of oil in renminbi. This will further cause the amount of renminbi held by oil exporters to rise. China has already launched a renminbi-denominated benchmark price for gold, and other commodities could soon follow.
Policy-makers face the difficult task of navigating China’s rebalancing away from an export-driven industrialising economy towards a mature services-orientated one. However, even accounting for the inevitable cyclical swings and structural slowdown in China’s growth, China’s global role can only increase. This creates the imperative for countries to increase their access to renminbi, via larger official reserve holdings, increased swap agreements, and potentially a greater resort to SDR conversion.
Danae Kyriakopoulou is Head of Research and Ben Robinson is Economist at OMFIF.
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