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China Takes Big Step Toward Internationalizing Currency

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The significant increase this year in the usage of the Chinese renminbi in trade finance, as reported last week by currency tracking firm Swift, is an important milestone in China’s plan to internationalize its currency, and one that investors like Teresa Kong, manager of Matthews Asia’s fixed income strategy, believe will serve to further bolster both China’s and the renminbi’s importance in the global financial system.

According to Swift, the renminbi overtook both the euro and the yen this year, coming in second behind the U.S. dollar as the currency of choice for trade finance. Although much of the trade activity involving the Chinese currency took place between the different regions of mainland China, Hong Kong, Taiwan and Singapore, this in itself is extremely important Kong said, and shows a much more widespread usage of the renminbi that is only set to continue going forward as regional activity also grows in importance. 

“The renminbi is increasingly important as a currency and we as investors should be looking at it more closely,” she said. “I think increasingly from an individual investor  perspective, it makes sense to have some allocation to the renminbi and as a corporate treasurer or a CFO involved In any kind of trade, it does make sense to hold some of your currency reserves in renminbi, even if you’re not directly exposed to it.

Since 2010, China has been steadily progressing along a path toward the internationalization of the renminbi and promoting its use as a reserve currency. While the dollar may still be dominant, “the increased use of the renminbi we’ve seen in trade finance means that traders want to use it, banks are able to supply it and the financial services firms are able to support it,” according to Edmund Harriss, manager of the Guinness Atkinson Renminbi Yuan & Bond fund in London. “This is an important marker for China because it shows that the policies of the central bank are indeed working, and although there has always been skepticism from people at every stage of China’s opening up, these gradual changes are needed for China to make the necessary transitions toward sustaining economic growth and delivering a higher standard of living to its citizens, even though the speed at which they are happening may not be to the market’s taste.”

China’s approach to change has always been methodical and the very important process of internationalizing the currency is no exception to that rule. The Chinese have approached making the renminbi an international reserve currency in a scientific manner, based largely on the study of the way in which the American dollar became the supreme currency for all global trade, Kong said. “The dollar really overtook the sterling between 1914 and 1923 and the Chinese have studied this history,” she said. Encouraging more companies to settle trade-related matters in renminbi has helped to further a more widespread usage and it has also helped to develop trade within China and the broader region in a significant manner.

As the renminbi’s importance continues to grow, Kong said that its usage will spread to beyond trade, and that there will, among others, a deepening of the local bond markets. “If you look at the offshore dim-sum bond market today, it is still relatively shallow in terms of the length of available bonds and you can really only get bonds of blue chip companies. I would like to see that market deepen and I think that that’s going to happen,” she said.

Harriss said he is also keeping an eye on the development of the Shanghai Free Trade Zone, which was launched in September.

Last month, Chinese authorities announced their plans to roll out financial sector reforms in the zone over the course of the next three months. Most of these measures will be implemented in a year, and then rolled out nationwide subsequent to that, Hariss said.

“I think we’re going to see moves to make it easier for foreign investors to invest more freely in China, including in the domestic bond markets. Clearly, China is opening up and while the process might be slower than many expect and many are sitting on the sidelines because of this, it’s important to look at where China will be in the next 10 or 20 years. With the reforms that we’re seeing, more money is likely to make its way into China, and while the renminbi overtaking the euro in trade finance may not be that critical as marker, it should nevertheless be attracting investors and making them consider China not as a market that just got lucky, but as a place of deeper transformation,” Harriss said.