Era of renminbi dawns as China’s influence grows
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By Patrick Zweifel
Chinese currency set to gain international status in three years
“The Chinese currency, the renminbi, is not terribly well known at the moment, but over my lifetime it’s going to become almost as familiar as the US dollar.” So said George Osborne during a recent visit to Shanghai.
At first glance, this might seem unrealistic. The renminbi is hardly a global investment currency and barely registers on central bank balance sheets. So any change would require a profound shift in the financial landscape.
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Yet the renminbi is evolving at a remarkable pace. As a medium of exchange and unit of account, it is on course to acquire international status in three years; in 10, it may unseat the dollar as the world’s reserve currency.
The renminbi’s growing stature is visible on many fronts. The first is trade. History shows the currencies of countries that play an important role in the global economy have developed into major players on the world stage. And with China now the globe’s biggest trading nation, the renminbi has momentum in its favour. It is already the world’s ninth most-traded currency and recently replaced the euro as the second most heavily-used currency in international trade finance.
The conditions are therefore ripe for the renminbi to become a major trading currency over the next three years. By then it should account for around 5 per cent of global trade, a fivefold increase on the 2012 figure.
Its transformation into a global investment currency is also progressing rapidly. Here, the catalysts are financial reform and capital market expansion. Under plans recently unveiled by President Xi Jinping, China aims to extend the yield curve for government bonds and create a capital market that serves the needs of a broad range of borrowers and investors, domestic and foreign. This development, alongside a prospective widening of the renminbi’s trading band, should boost the currency’s credentials as an international investment vehicle.
China’s renminbi-denominated debt market is already the largest in emerging markets. The volume of international bonds outstanding has expanded by some 800 per cent over the past three years and the market has played host to foreign issuers such as McDonald’s and Caterpillar.
While the market is largely off limits to international investors, Mr Xi’s reforms suggest this situation will soon reverse. So, over five years, the renminbi should become a top three issuing currency in the international bond market alongside the euro and dollar.
Ground to make up
It is as an international reserve currency that the renminbi has most ground to make up. Currently only 0.01 per cent of world central bank foreign exchange reserves are held in renminbi. That compares to 60 per cent in dollars and 25 per cent in euros. But this tiny percentage masks an underlying reorientation towards the renminbi – a process that began in 2005 when China abandoned fixed exchange rates.
Before then, the dollar was the only reference point for developing world central banks. By some distance the largest constituent of policy makers’ foreign exchange assets, it exerted a major influence on the behaviour of emerging market currencies.
Since 2005, however, a new pattern has emerged. The dollar’s pull on emerging market currencies – or the co-movement between the dollar and other units – has waned. Previously, when the dollar moved 1 per cent, emerging market currencies would head in the same direction by an average of 0.8 per cent. Today, the co-movement is closer to 0.5 per cent.
Scene is set
The dollar’s loss has been the renminbi’s gain. Where it once had no influence at all, a 1 per cent move in the renminbi now causes a 0.1 to 0.2 per cent shift in other emerging currencies. As China’s economic influence grows, this tendency can only strengthen. Should present trends persist, the currency could account for 30 per cent of central bank foreign exchange reserves by 2025, when it begins to threaten the dollar’s reserve currency status.
An obstacle on the path to renminbi dominance is China itself. It has shown reluctance to open up its capital account, while its export-dependent economy and huge holdings of US Treasuries means policies that lead to currency appreciation are not necessarily favoured by policy makers.
But the benefits of an international currency – low borrowing costs and reduced exchange rate risk – should eventually prove too alluring for the Chinese authorities to ignore. The scene is set, then, for the Chinese unit to come of age and for renminbi-denominated securities to evolve into core holdings for global investors, probably at the expense of US dollar assets. The era of the renminbi is upon us.
Patrick Zweifel is chief economist at Pictet Asset Management
