Goal of yuan convertibility within reach
Qu Hongbin expects the renminbi to be fully convertible in five years, not only because of the market's impressive growth so far but also, more importantly, because it is Beijing's goal
China is no longer just the world's biggest factory - it is the biggest factor in many parts of the global economy. "Made in China" is now being matched by "Bought by China" as the country's tourists, consumers and companies purchase more products, services, commodities and properties in other parts of the world.
Even as Western nations have succumbed to debt-induced slumber, China's continued expansion has dramatically improved economic prospects elsewhere in the world: some of its closest neighbours and many major commodity producers have been caught in the country's powerful slipstream. This gravitational pull is not confined to purely economic developments. Thanks to the rise of the renminbi, the world financial system is also beginning to be radically reshaped.
The renminbi has played a relatively limited role in international trade and capital markets but this is changing - fast. The pace of internationalisation of the "redback", as the renminbi is known by some, hasn't just taken off, it has soared. The proportion of Chinese exports and imports settled in renminbi has increased about six-fold in three years, to nearly 12 per cent; the pool of offshore renminbi, non-existent three years ago, now tops around 900 billion yuan (HK$1.1 trillion).
By 2015, the currency could account for a third of China's international trade and take its place among the world's top three trade currencies. But the story is much bigger than trade.
The rise of the redback is rapidly becoming an important story for those who manage renminbi foreign exchange risk or use the currency to invest.
The growth can be seen everywhere - from the foreign exchange and bond markets and new offshore centres like Singapore, Taiwan and London, to stock market investment schemes and foreign direct investment and Chinese direct investment overseas. The offshore renminbi market, introduced in 2010, has seen liquidity surge 2½ times between 2010 and 2012, and it is still rising strongly.
This, plus the introduction of a broad range of renminbi products, has significant implications for hedging, financing and investment. For example, international companies such as BP, Tesco and Volkswagen now have access to the currency through Hong Kong's booming dim sum bond market. These flows are going in both directions - in and out of China - through an increasing number of financial conduits being opened by Beijing.
But for China to have a truly global currency - as befits the second-largest economy representing around 11 per cent of global gross domestic product and over 10 per cent of world trade - the redback must become fully convertible, a currency that can be readily bought or sold without government restrictions. I'm confident this can be achieved within five years.
First, it is official policy - Beijing has made it clear that full renminbi convertibility is the ultimate goal of currency reforms. It is part of the current five-year plan (2011-15), a point that was reinforced at the recent National People's Congress.
Second, the window of opportunity has never been wider as many of the necessary elements are already in place - a balanced current account, a more flexible exchange rate that is close to its fair value, and rapid expansion of renminbi use outside China. At the same time, the country's new leaders appear ready to speed up domestic financial reforms.
For example, moves to free up interest rates, an essential part of the process, are gaining momentum and important share schemes such as the Qualified Foreign Institutional Investor and the Qualified Domestic Institutional Investor programmes look certain to be expanded; restrictions on individual cross-border capital flows are also likely to be relaxed.
Third, the renminbi is already more convertible than many people think. The currency is now freely available to the corporate world, China has currency swap agreements with around 20 countries and the restrictions on capital account trans- actions have eased in recent years.
But there is a precondition for full currency convertibility - accessible, deep and broad domestic financial capital markets that can handle all the stresses and strains that this process will entail. Although China's domestic equity markets are the world's third largest by market capitalisation, there are problems and irregularities that need to be fixed. For example, the bond market is still at a very early stage of development. The solution may lie in the pressing need to fund local government infrastructure projects, which is likely to trigger an expansion of the bond market in the coming years.
More importantly, Beijing must develop a stronger institutional and regulatory framework to improve market efficiency and control financial risks. In short, China must put its domestic financial house in order before fully opening up its capital account. However, all the signs suggest this is not just possible but probable.
Barring policy U-turns or economic shocks at home and overseas, the currency will soon be ready to take its place at the top table. Further renminbi internationalisation will reflect China's status as a global economic power and support its burgeoning trade and investment relationships around the world. Full convertibility will be the benchmark for making the renminbi a truly global and, eventually, a reserve currency that is an alternative to the US dollar.
Qu Hongbin is HSBC's Greater China chief economist