Renminbi replacing US dollar for trade as a new currency

The Chinese renminbi is on the brink of taking on an increased role in the Asia-Pacific region, probably over time replacing the use of traditionally dominant currencies such as the US dollar and the euro for certain transactions.

The currency has recently emerged, thanks to Chinese government policy changes, as a means by which Asian corporates can settle trades with their Chinese counterparts. This increased intra-Asian trading volume will lead Beijing to also consider allowing other trade-related insurance and derivatives denominated in renminbi to be done offshore, say bankers and regulators in Hong Kong.

This week, Norman Chan Tak-lam, chief executive of the Hong Kong Monetary Authority (HKMA), says Beijing was studying the idea of introducing more yuan-denominated investment products in Hong Kong, expanding from the renminbi-denominated bonds issued by mainland financial institutions as the only instruments allowed for Hong Kong investors.

At present, the renminbi is not fully convertible, but the Chinese government has made a number of arrangements with various countries so that trades between China and these countries could be settled directly in renminbi, instead of US dollars as in the past.

John Coverdale, HSBC's global co-head of commercial banking based in Hong Kong, says Asia has come to an important juncture where the renminbi trade settlement pilot scheme launched in July has effectively made the currency a new force governing intra-Asian cross-border trades.

"We are right at the dawning of the age of a wider convertibility of the renminbi currency and therefore a wider use of it for trade and other purposes," says Coverdale, adding: "We have not seen the evolution of a new currency for a long time. We can effectively call it a new currency in a newly emerged market. It's a new force."

Since the inception of the trade settlement pilot scheme, 173 transactions amounting to RMB230 million had been conducted between mainland China and Hong Kong. The pilot scheme allows for 400 approved Chinese enterprises in five approved cities including Shanghai, Guangzhou, Shenzhen, Dongguan and Zhuhai to settle trades with their counterparts in Hong Kong, Macau and Asean member countries.

Banks in these countries outside China are now allowed to open renminbi accounts with mainland banks for trade-related clearing, and enterprises in these countries can now also start to accumulate renminbi liquidity for trade purposes.

Recently, for example, HSBC helped a Hong Kong manufacturer of printed-circuit boards located in Guangdong province receive RMB15 million through its trade settlement services, which then used the funds to invest in renminbi-denominated bonds.

"The next evolutionary step is that you'd see increased volume of trade settled in RMB. The authorities in China will start to give us more exporters to settle with," says Coverdale.

Stanley Chan, head of HKMA's financial infrastructure development, says based on the US$434.78 billion value of total trade volume in Hong Kong and Asean countries, if 5% of such import and export volume were to be settled in renminbi it would translate into settlement volume of US$21.74 billion.

With US$129.9 billion total export value to China from Hong Kong and Asean countries in 2008, a 5% trade settlement will translate to renminbi liquidity offshore US$6.5 billion.

"The renminbi (when graphed against the exchange rates of the US dollar and other Asian currencies) has been stable since May 08. It (qualifies as) an alternative currency to the US dollar in this region when viewed against other Asian currencies' exchange rates versus that of the US dollar. Such stability incentivises companies in South-east Asia and Hong Kong to use renminbi for trade settlement," he told bankers who attended an Asia Risk conference earlier this month.

Chan says the payment and security settlement system of Hong Kong gives the city an advantage to develop as an important offshore renminbi clearing centre because of its seamless interface with the real-time gross settlement system of China.

Thus, he says if a South-east Asian bank wants to conduct FX transactions with a mainland bank - including derivatives transactions if so allowed in the future by Beijing - they could do so through becoming a direct participant of Hong Kong's real-time gross settlement systems, which is also linked with the US dollar and euro systems.

"More importantly, there will be interbank money market between participants of this system...as direct participants of the (Hong Kong) settlement system can now freely lend and borrow to each other," he says.

As the sources of fund and scope of assets in renminbi expand, banks might one day be allowed to also offer other financial services such as renminbi-denominated insurance policies.

Meanwhile, Coverdale says he also believes holders of Renminbi-denominated bonds are now considering using these securities to obtain secured lending - not only in renminbi but also for any other currencies.

However, he considers the development of a renminbi interbank market in Hong Kong being contingent more on the timing of when the currency becomes convertible.

"An offshore renminbi interbank market will not be developed until the currency is properly and freely traded. There is probably a limited appetite for holding a currency that is not freely convertible, so from a risk perspective an interbank market and convertibility of a currency tends to go hand in hand."