The Outlook for the Cross Border Use of the Renminbi
The renminbi formally joined the International Monetary Fund's Special Drawing Rights,a basket of reserve currencies,in October,and the move is likely to have major significance on the role of the Chinese currency on the global stage. The renminbi still takes a back seat to the US dollar as far as China's own cross-border payments are concerned. But it is now the fifth largest currency for global payments and the eighth largest as far as global foreign exchange transactions are concerned. The path ahead,however,may present a number of complications,among them the recent US presidential election and the possibility of more interest rate hikes by the US Federal Reserve. Brexit,the British referendum on leaving the European Union,also complicates the outlook for global currencies,including the renminbi. But new opportunities are also expected to arise,and the government has made it clear that it will work hard to create a favorable environment for the internationalization of the currency.
Over the last few years,the cross-border use of the renminbi has generally been growing. The Bank of China's Cross-border Renminbi Index (CRI),which reflects the level of renminbi cross-border transactions by tracking fund outflows,circulation of the currency offshore and cross-border renminbi returning from offshore,reached 253 points in September,2.5 times the level of 2011 (the base year at 100 points). This shows that the internationalization of the renminbi has made considerable progress over this period.
The more recent trend has been less favorable,however,as there has been a decline in the use of the renminbi in cross-border transactions,partly because of the decline in the currency's value.
From January to September,cross-border renminbi settlements reached 5.91 trillion yuan,down 16% from the same period of last year. It was the first year-on-year drop since 2009. Current account cross-border renminbi settlements reached 4.03 trillion yuan in the same period,down 26% compared with last year. The proportion of renminbi used in merchandise trade also was lower than the figure for 2015.
But cross-border use of the renminbi under the capital account has become a new growth area. From January to September 2016,settlements for cross-border direct investments reached 1.88 trillion yuan,up 21% from the same period a year earlier. There have been more bright spots in business related to the Shanghai-Hong Kong Stock Connect - which links the bourses of the two cities - as well as RQFII (the renminbi qualified foreign institutional investors program) and investments by overseas institutions in the interbank market. Moreover,the long-anticipated link between the Shenzhen and Hong Kong stock markets has also given capital account use of the renminbi a boost.
New Developments
The inclusion of the renminbi in the Special Drawing Rights mechanism will help build market confidence. But even before that policy formally went into effect,the World Bank issued the first bond priced in SDRs and settled in renminbi - another milestone for the currency.
If we examine official foreign reserves around the world,we see that the most important four currencies have been those included in the SDR basket. With the addition of the renminbi,we can expect central banks,reserve fund managers and the private sector to consider acquiring renminbi and renminbi assets. At the same time,the continuing effort to open up China's capital market will promote more capital inflows. According to data from China's State Administration of Foreign Exchange,foreign investors added a total of 222.2 billion yuan of Chinese treasury bonds between January and September in 2016,exceeding the total increase in the previous year by 131.5 billion yuan.
Over the past few years,when the renminbi was strengthening,the domestic exchange rate showed a sizable gap with the offshore rate. In this kind of environment,companies around the world were eager to take payment in renminbi,and there was a marked upturn in cross-border renminbi financing and exchange transactions. After the 2015 renminbi exchange rate reform,which effectively devalued the currency,there was greater volatility on the foreign exchange market. Coupled with a narrowing of the spread between onshore and offshore rates as well as the shrinking space for cross-border interest rate arbitrage,there was a drop in interest in foreign exchange transactions as well as trade financing products.
However,the market shifts have brought new business opportunities as well. When the Chinese currency was appreciating there was more interest in holding renminbi assets. With the decline of the renminbi exchange rate,some corporate entities may be inclined to borrow renminbi. This could provide new opportunities for offshore renminbi lending and trade financing,particularly as the government moves ahead with its "One Belt,One Road" initiative,which seeks to promote trade and infrastructure development in neighboring countries. Renminbi derivative products such as forwards,swaps and options could all see fresh demand.
In addition,the changes in renminbi onshore and offshore interest rates have made "panda bonds" more popular among offshore issuers. Since the beginning of 2016,issuers have included overseas sovereign institutions,international development agencies,industrial and commercial enterprises and financial institutions. The governments of Poland,South Korea,and the Canadian province of British Columbia,have all issued "panda bonds" in China,reflecting the confidence of the financial market in the renminbi.
The renminbi global settlement infrastructure has also been significantly enhanced. The