in financial markets, and even as a potential reserve currency, but China's government is reluctant to let go completely.
At the beginning of the eighties, when Deng Xiaoping set in motion the economic reforms that would transform China into a free market economy, the renminbi was devalued to make Chinese exports more competitive.
This was an era in which Chinese currency was so carefully protected that it was illegal for non-Chinese to possess it. Between 1979 and 1994, visitors to China were not allowed to spend renminbi, but had to use foreign currency to purchase Foreign Exchange Certificates (FECs), issued by the Bank of China. The certificates were only accepted by approved restaurants, hotels and stores, including those selling foreign "luxury goods", such as imported alcohol and cigarettes.
This was an era in which Chinese currency was so carefully protected that it was illegal for non-Chinese to possess it. Between 1979 and 1994, visitors to China were not allowed to spend renminbi, but had to use foreign currency to purchase Foreign Exchange Certificates (FECs), issued by the Bank of China. The certificates were only accepted by approved restaurants, hotels and stores, including those selling foreign "luxury goods", such as imported alcohol and cigarettes.
Unsurprisingly, the unwanted restrictions on how foreigners could spend their money and the increasing number of Chinese who wanted access to luxury foreign brands caused a black currency market to spring up, in which FECs or foreign currency were sold for renminbi. By 1994, the certificates were no longer issued, and foreign residents were permitted to use renminbi notes, just like everyone else.
This was an era in which Chinese currency was so carefully protected that it was illegal for non-Chinese to possess it. Between 1979 and 1994, visitors to China were not allowed to spend renminbi, but had to use foreign currency to purchase Foreign Exchange Certificates (FECs), issued by the Bank of China. The certificates were only accepted by approved restaurants, hotels and stores, including those selling foreign "luxury goods", such as imported alcohol and cigarettes. Unsurprisingly, the unwanted restrictions on how foreigners could spend their money and the increasing number of Chinese who wanted access to luxury foreign brands caused a black currency market to spring up, in which FECs or foreign currency were sold for renminbi. By 1994, the certificates were no longer issued, and foreign residents were permitted to use renminbi notes, just like everyone else.
Just sixteen years later, the renminbi is the most likely candidate to become the world's next principle reserve currency, a possibility that is both favored and feared. "Anchored in a quasi-Cold War era mentality, renminbi internationalization is frequently presented in rather sinister undertones," Jeremy Stevens, a Beijing based economist for Standard Bank wrote in a recent report, BRIC-Africa: the redback's rise is an opportunity for Africa. Stevens emphasizes that the currency's internationalization and its potential as a reserve currency are different matters. "First, internationalization is about transactions: buyers and sellers doing business in the currency. A reserve currency is about the desire to hold the renminbi as a store of value. Renminbi internationalization is about the former, intending to add efficiency and resilience to China's trade and investment flows."
The internationalization of the renminbi will be a gradual, decades-long process, but it is already well underway. Hong Kong's offshore market plays a critical role in renminbi internationalization, and has benefitted from a steady loosening of restrictions over the past few years. The first renminbi denominated bonds - often called dim sum bonds - were issued in Hong Kong in 2007, but most were simply denominated in renminbi and payable in US or Hong Kong dollars, and did not raise renminbi capital. Only the proceeds from renminbi bonds that were issued by PRC banks under an annual quota system, and subject to approval by the People's Bank of China, could be taken back to the mainland.
In September 2009, the Ministry of Finance became the first Chinese institution other than banks to issue a renminbi denominated bond in Hong Kong. Subsequent to this, the Hong Kong Monetary Authority announced that other non-financial firms would be permitted to raise renminbi capital via its offshore bond market. Approximately 50 multinational companies have opted to do so, and the market experienced rapid growth last year after restrictions on moving renminbi from offshore to the mainland were further relaxed. Issuance surged from the equivalent of US$5.47 billion in 2010 to US$18 billion by the end of August this year.
McDonalds and Caterpillar, the US based earthmoving equipment manufacturer, were the first multinationals to use the proceeds from renminbi denominated bonds to finance their projects in China. Caterpillar's US$150 million bond issue in November 2010 was less costly than taking out a loan in China or converting the money from dollars into renminbi, Richard Lavin, a group president at Caterpillar told the New York Times.
Efficiency and cost effectiveness have driven renminbi internationalization in other areas too. In June 2009, China's State Council established a pilot scheme in which the renminbi could be used for trade settlement within designated regions. The program began by allowing renminbi settlement for exports and imports between participating enterprises in five Chinese cities and their trading counterparts in Hong Kong, Macau and the ten nations of ASEAN (the Association of Southeast Asian Nations). As part of this program, renminbi settlement in and out of mainland China could be made without PRC approval. Following its success, the pilot scheme was extended to allow two-way settlement between twenty locations in mainland China and all countries worldwide in June 2010.
It should come as no surprise that in Africa, where China is the continent's largest trading partner, methods to promote the use of the renminbi are already in place. Africa's largest bank, the Standard Bank Group, is expecting at least 40 percent of Africa's trade with China to be transacted in renminbi by 2015. That puts estimations at an equivalent of US$100 billion, which exceeds China and Africa's total trade volume last year.
The bank's optimism is not unwarranted. As many as one million Chinese people live and work in Africa and approximately 1500 Chinese firms are operating in the 17 African countries in which Standard Bank is present. Africa welcomes Chinese investment, and the continent's resources and large scale infrastructure deals offer China investment alternatives to dollar-denominated fixed income products. Standard Bank's Jeremy Stevens points out that because high level political leaders want to grow the reach of the renminbi, Chinese firms going out into Africa or already in Africa are likely to find it easier to access capital, which they will then use to invest in the continent.
The bank has already launched renminbi services in 16 African countries, including South Africa, Nigeria and Angola, and turnover from renminbi business reached RMB500 million (US$78 million) over the past six months. The bank has also utilized Hong Kong's offshore renminbi market to introduce renminbi denominated products to meet their client's increasing need for hedging, funding and wealth management services. Renminbi notes were issued to clients in South Africa, Zimbabwe and Ghana in July this year and short term renminbi credit facilities, renminbi denominated accounts and a host of trading products are also likely. "It seems obvious to me," Stevens writes, "that China will be more successful in globalizing the renminbi and transacting in renminbi in Africa than elsewhere."
The UK has also taken steps to improve its economic relationship with China. During a visit to the UK by Chinese Vice Premier Wang Qishan in September, formal backing was given for UK banks and financial institutions to develop London as an offshore financial center for renminbi trading. Both governments issued a joint statement saying that the countries "welcomed the private sector interest in developing the offshore [renminbi] market in London and the growth of the market to date."
While London's potential as an offshore renminbi center is certainly a positive step for renminbi internationalization, a handful of new initiatives announced in August by Li Keqiang, another of China's Vice Premiers, have affirmed Hong Kong's position as the foremost offshore renminbi settlement center. The new measures include expanding the renminbi cross-border trade settlement from 20 provinces in China to the whole nation, establishing a formal system for remittance of renminbi from Hong Kong to the mainland, and allowing Hong Kong enterprises to use offshore renminbi proceeds for onshore investments.
These measures clearly demonstrate China's commitment to internationalizing its currency. Chinese enterprises and their trade partners will continue to benefit from the lower transaction costs that renminbi settlement facilities offer. Extended use of the renminbi also reduces the inflow of US dollars into China, reducing the pressure on China to allow its currency to appreciate.
China's move towards internationalization is not guaranteed to succeed. It is recognized, both inside and outside of China, as an unusual, unparalleled process. Paola Subacchi of the British think-tank, Chatham House, points out that "the attempt to create an international and eventually fully convertible currency through a policy-driven process is unprecedented - nothing like this has ever been tried before, even partially. Past experience shows that convertibility and opening of the capital account have always preceded the international use of a currency, rather than the other way round."
While China is pioneering new ways to increase its leverage in the global economy, the future super power is proceeding cautiously. The renminbi is still not fully convertible and fears within the leadership about the impact of volatile foreign exchange markets on both domestic stability and the country's immature financial system mean that the renminbi is still a long way from reaching the importance of the larger Chinese economy in global markets.
