There has been much talk of the Internationalisation of the RMB and the recent ‘currency war’ between the US and China with the US exerting pressure on China to appreciate its currency. Whilst the Chinese leaders are unlikely to yield to US pressure, they recognise that there is a need to gradually appreciate the currency to counter the risk of inflation and adjusting the Balance of Payments without damaging and destabilising China’s export industries. China has come a long way in the last 3 decades and has become a key player on the international stage. China is the second largest recipient of foreign direct investment (FDI), with inflows of $95 billion in 2009. It has overtaken Japan in the second quarter of 2010 as the world’s second largest economy and overtaken Germany as the world’s largest exporter. It holds the largest share of foreign exchange reserves (just under $2.5 trillion). However, it does not have a currency that reflects its prominent role and therefore recognises the need to move to a more flexible exchange rate regime and a fully convertible RMB.
RMB is not fully convertible and is not a unit of account for exchange means in international transactions
Despite its prominent role in the world economy, the RMB is not fully convertible, creating a mismatch on its international balance sheet between liabilities that are typically denominated in RMB. China’s over-reliance on the Dollar can be associated with the risk of excessive exposure to liquidity shortage within the world economy and the consequent reduction of trade finance as experienced by the lesson learnt from 2007-2008 financial crisis. To use the RMB as a future means of payment in international trade transactions would reduce the impact of international financial market volatility on its economy. The Central Government will also face less pressure in the managing of its huge foreign exchange reserves. China has no past experience nor road map to pave a way to develop RMB as an international currency so its challenge is immense. China does not have a reserve currency with intrinsic value linking and convertibility to gold. The RMB can only be compared to the Dollar itself. China also faces another challenge if its currency is channelled into the hands of foreign holders. With its huge current account surplus, this is not going to be easy without further expanding the Dollar element on the asset side of the Central Bank’s balance sheet.
Planning Currency Moves and paving the way to Internationalise the RMB
RMB revalued its decade 8.28 exchange rate peg to USD on 21 July 2005 to 8.11 to reform the exchange rate regime to meet the needs of China and world financial markets and moved to a managed float. In July 2008, RMB was re-pegged to USD to help exporters cope with sliding demand triggered when the global financial crisis intensified. Striving to increase RMB flexibility, it abandoned the 23-month re-pegging to USD. The RMB has gradually appreciated to help curb inflation and assuage the demand of its trading partners. As consumer prices rose 4.4% MoM in Oct 2010, PBOC raised RMB rate 0.31% to 6.6242 on 11 Nov2010, the strongest increment since the peg was scrapped in July 2005. Beijing is relying on its market power to encourage foreign businesses, especially from its regional neighbouring countries, to use the RMB to settle its transactions with Chinese firms whilst building a RMB denominated asset offshore market in Hong Kong without prematurely opening the capital account and increasing the imbalance in its international balance sheet. Success will depend on a combination of well-designed, controlled policies and market forces with an objective for Shanghai to be developed as an international financial centre by 2020.
Formation of the offshore RMB market
Hong Kong is China’s RMB offshore centre under the “One Country, Two Systems” which is needed to maintain the status quo on the capital account and to ensure that any possible negative impact of the experiment can be successfully “walled off” from the domestic market . Since 2004, daily permitted conversion of RMB 20,000 by HK residents has accumulated to approx RMB 80bn by the middle of this year, mainly made up of low yield deposits, remittances, exchange and credit card services driven largely by anticipated RMB appreciation. In May 2009, China’s State Council granted approval to 2 foreign financial institutions registered in HK, namely HSBC and the Bank of East Asia, to issue RMB denominated bonds. In July 2010, offshore RMB market gained pace with the signing of the Supplementary Memorandum of Cooperation on the Expansion of the RMB Trade Settlement Scheme which enabled free circulation of the RMB outside the Mainland. In August 2010, China eased restrictions on foreign offshore Bank’s access to the interbank bond market to offer products with more favourable terms which attract even greater demand for the RMB offshore.
Is the internationalization of the RMB feasible and realistic in the current environment?
According to the HKEx Chief Executive Charles Li , the RMB is likely to evolve in 3 stages, namely gaining international acceptance in becoming a currency of trade (5-10 years), a currency of investment (10+ years) and ultimately a reserve currency (20+ years). Today, trade settlement in RMB has amounted to RMB 91.6 bn and is still growing rapidly despite current capital account and convertibility constraints. The issue is not whether the RMB will become an international trade currency but as to how fast this can be achieved with market consensus being that full convertibility of the RMB is just a matter of time and revaluation will be forthcoming in the interim. To become a reserve currency, the capital account also needs to be convertible. Further investment options need to be available for Investors to hedge their risk.
Strategy of structural reforms and domestic consumption
It is expected income distribution, healthcare, provision for public housing, other social services will be the main theme of China’s 12th Five Year Plan. Following the last financial crisis, China is shifting from an export and fixed investment-led economy into consumption-oriented economy to remove the heavy reliance on export growth. Addressing huge income gap between wealthy urbanites and the poor farming communities is also on its agenda. Spending on Health Care will likely increase 7 fold between 2008-2018 with the constructing of 2,000 new county hospitals and other rural clinics. Other reforms will include building roads, new energy, equities and fixed assets. Central Government has promised to cut carbon dioxide emission per unit of GDP in 2020 by 40 to 45% from the 2005 levels. 80% of external funding for the Chinese economy comes from bank loans, it raises the need for funding source diversification through the Capital Market in Corporate loans and equities. Mainland insurance and securities companies could be the biggest beneficiaries of these reforms. China will seek to maintain stability on macro, fiscal policy and monetary policy. RMB exchange rate should also maintain relative stability so that domestic manufacturers and exporters can better predict and adjust to the market. Any significant move on the RMB could see foreign money pouring into the country which will cause inflation. If revaluation is large, domestic companies face a risk of being priced out of the market and impact export growth leading to higher unemployment and social unrest. Chinese leaders appear to have concluded that RMB revaluation is a contingency. Given that a more flexible currency mechanism is forthcoming, Beijing needs to prepare its country’s financial system for possible shock effects from exchange reform and make effective the State enterprise.
Business Opportunities for Financial Institutions like Credit Suisse
The earliest beneficiaries of the RMB’s Internationalization will be the Banks, Insurers and Asset Managers with their products offerings. Credit Suisse has strong Investment Banking, Asset Management and Private Banking capabilities and has positioned itself in recent years to take advantage of the reforms and huge growth in China. There will be a growing market in the acquisitions by Chinese state-owned enterprises in the coming years. Chinese Corporate, financial institutions and Government alike will require significant capital in the next 5 to 10 years and the sectors most likely to be in need of financing are financial services, infrastructure and natural resources. The last five years have seen spectacular IPOs in the Chinese market and this trend is likely to continue as long as the Chinese economic growth is maintained.
Credit Suisse positions itself in China
Credit Suisse is a market-leader in Investment Banking (including Corporate Banking), Asset Management and Private Banking and offers multi product suites, first class execution and distributions, trade settlements and capital market advisory services to our global clients. CS is increasing its business presence in China and has made numerous strategic market professional hires whilst additionally undertaking strategic joint ventures. Credit Suisse has entered into a joint venture in Aug 2010 with ICBC to form ICBC Credit Suisse Asset Management Co. It raised more than RMB 14 bn ($ 2.1 bn) in China’s biggest bond fund ever called “The ICBC Credit Suisse Double Profit Bond Fund”. The fund invests in domestic Government debt, Corporate bonds, short term bills and RMB denominated Convertible Notes and is popular with investors sidestepping a weak stock market. Credit Suisse has also entered into a joint venture with Founder Securities Ltd, the first securities JV approved by the Chinese regulators since new guidelines were put in place in December 2007. The JV was launched with less than 50 staff but has doubled its head count in less than one year with further plans for expansion, betting on a healthy pipeline to underwrite debt and equities offerings, IPOs and M&As in China’s domestic market. For the nine months ending 30/9/10 Credit Suisse has been involved in 11 M&AA deals with a total volume of US$10.443bn, a market share of 8.8% and an overall financial institutions ranking of 4th (Bloomberg). Credit Suisse Private Banking has increased its headcount hire of high calibre Private Bankers to take advantage of the rapidly rising number of affluent households. It is estimated that nearly 1 million Chinese households have financial assets exceeding US 1m. China’s savings rate of appx 55% of GDP lacks competitive and efficient financial services for investments growth. China is the third-largest wealth generator in the world, with USD 16.5 trillion in total household wealth and is behind US’s 54.6 trillion and Japan’s 21.0 trillion but could rise 111% to USD 35 trillion by 2015 overtaking Japan to become the second highest in the world if growth continues. Credit Suisse is looking to open new offices in China and will leverage further its dominance with good infrastructure and foundation to build up the Private Banking business, noting at the same time the challenges that come with it in terms of OECD tax treaty, cross-border restrictions and the hiring of experienced talent. As CEO, as much as there is huge growth opportunities for the Banks to increase our global presence in China to achieve bigger revenues for our shareholders, we must ensure that optimal service levels to our clients needs are maintained and to have a rigorous infrastructural, operational, capable resources and a strong regulatory frame-work to adapt to the cultural differences, regulatory policy changes in China and market forces. There is a need prepare ourselves on some of the risk and challenges if the RMB revalues and the eventual Internationalisation of a fully convertible currency.
Risks and Challenges should the RMB revalue or appreciate
Foreign exchange risk management and mitigation will be key. A platform to better match payables and receivables minimizing FX risks and costs associated with potential currency mismatches and on Corporate Earnings from US to CHF should RMB devalues Ensuring first class regulatory risk management systems and highly qualified staff Agility in responding to local regulatory changes and market forces due to large revaluation impacting domestic companies and sectors that Credit Suisse has exposure to. Meet the regulatory minimum Capital adequacy and comply to new Basel III standards Significant revaluation impacting China’s export growth resulting in high unemployment and social unrest. Competition for Foreign Banks particularly if they are constrained in their loan growth or find it difficult to obtain approval to open new branches. Cultural barriers and the challenges of attracting, training and retaining good calibre individuals given the increased competition for experienced professionals and the possibility that a number of local market professionals will inevitably be lured back to the Domestic Banks as local financial institutions become more competitive in terms of capabilities, career prospects and remuneration The Chinese market for Private Banking is still immature and strictly regulated. It will take much time and effort to educate various parties including clients. Associated costs involved in increasing the presence in China such as office accommodation, personnel, infrastructure etc and the uncertainty as to how soon such an operation will become profitable against a backdrop of fierce competition.