China watchers could be forgiven for viewing the country’s past attempts to internationalize its currency with some skepticism. Certainly, there is reason for distancing oneself from the breathless excitement that accompanies any move toward expanding the global role of the renminbi, together with forecasts of America’s imminent demise as the world’s economic leader.
The US, for all its faults, will not be superseded by China in the near future, and the renminbi, for all its strengths, still has a long way to go before it can be considered a truly global currency. But the process has begun – and the question for Beijing is how far along that path it is truly willing to go.
Demand is certainly not a problem. With widespread expectations that the renminbi will continue to appreciate slowly over the next year, investors have been clamoring to get their hands on redbacks.
Hong Kong is the front line: By the end of November last year, total renminbi deposits in the territory had reached US$42 billion, while Hong Kong companies used up their annual cross-border trade settlement quota of RMB8 billion (US$1.21 billion) by October. Cheung Kong Holdings (0001.HK) Chairman Li Ka-shing has floated the idea of a US$1.5 billion renminbi-denominated IPO for a real estate trust later this year – it would be Hong Kong’s first renminbi IPO.
It has also been a hot location for the issuance of renminbi debt. Following successful bond issues by companies including McDonald’s (MCD.NYSE) and Caterpillar (CAT.NYSE) that helped to double renminbi bond issuance in Hong Kong to US$5.36 billion in 2010, the World Bank issued its first renminbi bond in more than two years, a vote of confidence in the renminbi debt market. It was joined by China’s Ministry of Finance in a US$1.2 billion issue; Bank of China (BoC; 601988.SH, 3988.HK) said it would issue US$3 billion in bonds by the end of 2012. Fund managers have been lining up to establish renminbi bond funds to let investors take advantage of not just interest yields, but appreciation as well.
It’s not just in Hong Kong, either. Russia’s Micex Stock Exchange became the only place outside of China to offer direct trading in renminbi in mid-December; on the first day of trading transactions beat estimates by 64%, prompting the exchange to extend its trading hours.
Then in January, Bank of China began allowing US customers to trade renminbi – within certain limits for individuals, but with no limits for businesses. Although other banks, including HSBC (HBC.NYSE, HSBA.LSE, 0005.HK) already offered such services, this was the first time a state-owned commercial bank had gotten involved, a clear indication of Beijing’s implicit support of greater international use of the currency.
There have been more explicit signs of the government’s intentions, too. Dai Xianglong, chairman of the National Council for Social Security Fund, said in a speech that China should “steadily promote” internationalization of the renminbi. He called it a step toward advancing reform of the international monetary system through currency diversification. He also said internationalization would take 15-20 years.
But Beijing should be aware that things may not go according to its own calendar. Every inch given in terms of expanding the offshore market for renminbi – as it did once again in January, allowing domestic companies to move the currency offshore for use in acquisitions and in new businesses, subject to government approval – is an inch lost in terms of control.
Demands for further changes will accelerate as offshore holders of renminbi begin looking for ways to invest in China using the currency.
These concerns may exacerbate the risks that China sees posed by capital inflows. Finding new ways to keep out “hot money” has been a favorite pastime in Beijing. As expectations for renminbi appreciation continue to rise, as China’s interest rates remain relatively high and as the country’s economy continues to grow quickly, the pressure will only increase.
There are ways to mitigate this pressure – one academic associated with the People’s Bank of China suggested that China impose a tax on conversions of foreign currency into renminbi – but these are ultimately distractions from the more central issue.
While the steps taken toward renminbi liberalization have been limited so far, Beijing has long since passed the point of no return. For all the leadership’s desire for control, it should be increasingly clear that internationalization is in the best interests of China – not to mention the global economy.
As the offshore market increases in size, conservative elements in Beijing may become alarmed by the obvious global hunger for renminbi, and push for stricter measures to retain control. Cool heads will need to prevail to ensure that the leadership doesn’t stray from its course. Beijing does not want to encourage offshore speculation in its currency, but will increasingly have little choice in the matter. The sooner it comes to that realization, the better.