China’s currency, the renminbi or yuan has always been a subject of concern for trading partners. The tightly controlled currency rarely reflects the global give-and-take necessary for a truly convertible monetary unit of trade. But an experiment is taking place in Canada to loosen currency controls. Is Beijing kicking the tires on a new convertible? Last month (November), Canada became the latest testing ground for China’s experiment in gradually loosening currency controls. Under a program that establishes what are called overseas “trading hubs” (sometimes termed “trading zones” or “trading centers”), Chinese authorities approved a three-year, $30 billion currency swap agreement with the Canadian dollar and granted an approximately $8 billion quota for Canadian investors to hold onshore Chinese domestic stocks and bonds. The Chinese government appointed Industrial and Commercial Bank of China as clearing bank for Canadian dollar to renminbi transactions. These moves follow similar actions in countries across the globe. In recent weeks, Qatar gained the ability to directly trade riyals with renminbi. Australia has announced a zone with details to follow. Germany and Britain established similar hubs earlier this year.
The Chinese government sanctioned renminbi trading offshore only in 2009, with Hong Kong the sole center. Before the new renminbi hubs were created this year, however, those buying Chinese goods or selling their own products to China had to first convert their home currency into US dollars. This sometimes-cumbersome process multiplied currency risks and uncertainties. Various studies indicate the new hubs will trim as much as 5% from the price of doing business. “Five percent on 70-odd billion dollars worth of exports, that’s a tremendous cost savings right there,” says Peter Hall, chief economist with Export Development Canada. AdvantageBC in their release of the results of a recent study, entitled “Potential Benefits of a Canadian-Based RMB Settlement Centre,” concluded the “potential impact on China-Canada trade from the currency exchange savings associated with eliminating the need to use US dollars ... is estimated as being up to $480 million in additional Canada-China trade—including up to $120 million in additional BC-China trade.” These new trading hubs illustrate China’s controlled approach to its currency liberalization and underscore trade’s central role in government thinking. They also prompt two big questions: Will these zones make any kind of difference in trade – and possibly shipping? Do they act as precursor to more dramatic moves in making the renminbi a fully convertible, international currency? The answer to both is yes. However, don’t expect anything overnight. “There’s slow and steady progress, but they have a long way to go,” says Carol Osler, a professor at Brandeis University International Business School, whose specialty is currency trading and exchange rates. Chinese officials “are so cautious about this, they want control every step of the way.” How Much is the Renminbi Worth? Michal Krol, a researcher at the European Centre for International Political Economy and a specialist on China, sees these moves as “examples of the incrementalism that takes place in China.” For years, many governments, economists and businesses alike have criticized China for undervaluing its currency through an artificially low exchange rate. Some have maintained that the renminbi is actually worth as much as one-third more than current rates and that this artificial exchange boosts Chinese exports while dampening demand for non-Chinese goods in China. Washington is especially critical and understandably so. In September – the latest month available – America’s trade deficit with China surpassed $35.5 billion, a record gap. Beijing has responded as it often does in issues related to major policy shifts, arguing for cautious gradualism. In 2011, officials at the State Administration for Foreign Exchange announced a timetable that promised the renminbi would be fully convertible by 2016. These days, no one accepts that schedule. While a 2013 HSBC study suggested full convertibility by 2018, some economists believe a free float may not take place before the end of the decade. Many are reluctant to hazard a guess when it may happen. “Even 2020 seems optimistic,” says Osler. Chinese officials and economic planners appear worried not only about losing export advantages, but about the volatility that a floating exchange rate brings. While those overseas would welcome a fully convertible currency as impetus to Chinese investment abroad, Beijing remains concerned about capital flight and dampened domestic investment if the renminbi is completely freed up. The renminbi has, in fact, gained some value over time. However, the pace has been slow and the trajectory has been reversed over the past several months. At the current exchange rate of RMB6.16=$1, the renminbi now is worth 25% more than ten years back, although only 10% more than in 2009. Until 2005, China pegged its currency against the US dollar. The Chinese government a decade back initiated a trading band, a kind of managed float. The Bank of China sets the parameters, with trading bands limited to 2%. “It is still undervalued,” says Maarten Spek, financial markets analyst with ECR Research, an Utrecht, Netherlands-based independent financial research consultancy. Yet Spek, like some other neutral authorities on monetary issues, is sympathetic to the notion of phased convertibility over an all-at-once, “Big Bang” freeing of controls. “It’s a better strategy than a Big Bang,” says Spek. “If they were to do it all of the sudden, there would be a lot of havoc in the marketplace.” To bolster its case, Beijing has to look no further than to neighboring Japan, which was forced to suddenly and dramatically revalue the yen in 1985 under pressure from the United States, the so-called Plaza Accord. That triggered an economic disruption and long-term deflation whose effects are being felt to this day. However, many economists see full convertibility as pretty much inevitable. “It’s going to happen,” says Krol. “The process is going to be accelerated.” Already, for example, several central banks hold renminbi in their basket of foreign currency reserves. China’s currency “is much more on a trajectory to a free market,” says Osler. “It’s very different than it was a decade ago.” Emotive issues related to the renminbi exchange rate have masked the growing importance of the Chinese currency in trade. The renminbi is now the world’s second most popular currency in terms of trade settlement, behind only the dollar, according to the Society for Worldwide Interbank Financial Telecommunication or SWIFT. The renminbi eclipsed the Euro last year. Since China began to allow cross-border, renminbi trade settlements in 2009, the ascent has been dramatic: Last year, China settled the equivalent of almost $840 billion, or 18% of its total trade, in renminbi, a six-fold increase in three years. HSBC predicts 30% of trade will be settled in renminbi by the end of 2015. In terms of letters of credit, the renminbi is third behind the US dollar and the Euro. That compares to overall currency trading, where the renminbi ranks ninth, according to the Bank for International Settlements. Advantages in Transaction Costs There are obvious advantages to directly trading in renminbi without first converting to US dollars. Perhaps the biggest is that it lowers transaction costs. In November, the Deutsche Bundesbank, quoting a Deutsche Bank survey, says the direct Euro-renminbi trade allows German enterprises to negotiate “average price reductions of just under 5%.” This direct renminbi trade simplifies the process as well. It substantially reduces foreign exchange uncertainties in terms of pricing, financing and carrying costs. For smaller importers and exporters, managing currency swaps is difficult enough without mandating the US dollar as a kind of third currency intermediary. Take Canada, for example. Before the swap agreement, Canadian businesses – or their bankers – were forced to first convert Canadian dollars to US dollars, then convert US dollars to renminbi in Hong Kong. “The incentives are much greater for a smaller shipper,” says Export Development Canada’s Hall. The new arrangement reduces foreign exchange risks. It also allows the use of renminbi financing instruments and holding Chinese currency for future transactions. An Australian National University study this year said almost 75% of Chinese and Australian businesses believe renminbi settlement will result in reduced foreign exchange risks and more favorable pricing. The ability to use renminbi should expand the overall business universe, advocates maintain. An HSBC survey indicates more than half the Chinese suppliers it polled would be willing to discount transactions if business is settled in renminbi. Hall believes the new arrangement in Canada will likewise spur new business and trade. These new trading hubs “are a big thing,” concludes Osler. A study conducted for the Vancouver Economic Commission maintains that the new currency hub will heighten demand for the Vancouver port. In theory at least, shipping costs can be reduced and better controlled. Shippers can price in renminbi. In the case of Canada, for example, the port of Vancouver can now price in Canadian dollars for shipments from China. Hall believes that the arrangement will also help the Port of Prince Rupert, northwest of Vancouver, which is making a big push for business not only between China and Canada, but goods bound from China to the US Midwest. Yet, even as they open up renminbi trading, Chinese officials continue to keep a grip on the process. Each new currency swap, for example, has a quota. There’s no formal mechanism for additional funds, although Krol, for one, believes “the quota system is going to be replaced by something much more flexible.” This kind of caution marks China’s conservative approach to change, but also highlights a continued ambivalence toward longer-term economic goals. While labor costs in China increase and planners stress the need to eventually transform the Chinese economy into one that is more consumption driven, many officials continue to cling to exports as the quickest means to job creation in the poorer, inland regions. Likewise, Chinese planners have often voiced a desire to lessen dependence on the US dollar, but refrain from any action that would seriously undermine its reserve holdings. Andy Langenkamp, a political analyst with ECR Research, likens these currency hubs to other Chinese efforts to strengthen and modernize the country’s financial and banking system. That includes a much ballyhooed currency free trade zone established in Shanghai last year. Langenkamp also cites a first-ever deposit insurance scheme, draft rules of which were released in late November. The deposit insurance is part of an effort to liberalize interest rates. The currency hubs are “part of a much bigger strategy,” Langenkamp says. “China is opening up to the world.”