August 6, 2015    4 minute read

Renminbi: A Rising Currency

   August 6, 2015    4 minute read

Renminbi: A Rising Currency

Since the Chinese Renminbi, abbreviated as RNB, was de-pegged from the US Dollar (USD) in July 2005, the USD/CNY has depreciated by more than the 30%, demonstrating as the RNB is gaining acceptance around the world. Its unit of measure is the Yuan, abbreviated on markets as CNY.

The Renminbi, which literally means “People’s currency”, was issued shortly before the takeover of the mainland by the Communists in 1949. For decades it has been exchanged at unsatisfactory levels because of the command economy established in China. In 1997 it was pegged to the US Dollar, till July 2005, when the peg was removed. After that, the RNB has been controlled by the Chinese Central Bank, People’s Bank of China (PBoC), by imposing a bandwidth in which the currency can float. The trading band widened from the +/- 0.3% against the USD, set right after the removal of the peg, to the current +/- 2%. According to PBoC officials all the restrictions should be removed by the end of 2015.

An increasing number of trades, approximately one fifth in 2014, have been settled in Chinese currency. Deposits offshore are also increasing: the leading offshore centres are Hong Kong, London and Singapore, followed by Taipei and Seoul. According to Standard Chartered, already 60 banks are investing in renminbi assets.

As part of the process of internationalisation of its currency, and in an attempt to reduce drastically capital outflows that China have been facing as of late, the Chinese government is pushing towards the inclusion of the RNB in the Special Drawing Right (SDR), a global reserve asset that includes the Euro, Dollar, Pound and Yen. An inclusion would mean a support by the IMF to the RNB, which importance would be officially recognised and therefore the RNB would be finally seen as a reliable and sound investment. According to Christine Lagarde, IMF’s Managing Director, the inclusion

“is not a matter of if, but a matter of when”

Another reason is that if the RNB became a reserve currency, China would be able to shift wealth from FX reserves to the private sectors and thus lessening the impact on China of monetary policies of other economies, especially the US one. According to Daniel Tenengauzer, Emerging Markets FX strategist at RBC Capital Markets;

“as the dollar strengthens due to the FED interest rate hike, the Renminbi will become too expensive”

This would be a great problem for China, since it is already facing deflationary pressure, reducing its growth rate, already very far from rates seen in the past years.

However investing in China might come with some risks, both political and financial, as the PBoC does not leave market forces to act freely. An example is given by the 6-month ban on share selling by big shareholders following the boom and burst of the stock market which led to a drop in the Shanghai Composite Index of 30% from mid-June. This could set back SDR acceptance, which is based on a currency being freely usable.

“The decision about the Renminbi’s inclusion in the basket hinges on financial market development, further opening of the (China’s) capital account (to global investors) and greater exchange rate flexibility”

Eswar Prasad, former IMF country head for China

In addition to such, according to a FT analysis:

“The market lacks derivatives that would allow investors to hedge risk or make bearish bets. The interest-rate swaps market is relatively liquid, but more sophisticated tools such as cross-currency swaps remain thinly traded. Equity derivatives are still in their infancy, with futures and options only available on broad indexes, not individual shares”

The Chinese stock market proved to be unstable and fragile, often facing capital outflows. Strong reforms are needed to make the market more attractive to investors. The market needs to be free, as the interventions by the government cause investors to be fearful of being locked into investments made in China; moreover the government needs to find ways to stabilise growth and minimise risks. As China demonstrates to proceed towards reforms, the RNB is set to increase its importance. Will RNB have the same importance of China as world’s biggest economy? One thing is for sure: one year ago the RNB was the 35th most traded currency, today is the 5th most traded. Renminbi has in fact been used more than the Japanese Yen (JPY), the USD and the Hong Kong Dollar (HKD) for payments between China and the Asia-Pacific region over the past four years.

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