The Long March – Yuan has a way to go

Yuan has a way to go yet in global markets

THE renminbi, which currently accounts for less than one per cent of total world reserve currencies, is expected to reach four per cent in five years as it erodes the importance of the pound and the yen in the global basket . . .

THE CHINESE CURRENCY, the renminbi (RMB), had something of a coming-out party in 2009 when nine provinces were chosen to experiment with trade settlements in yuan. After a slow start, RMB trade settlements took off from 2011, generating considerable discussions around the world as to the RMB’s role in global finance.
Hong Kong-based economic strategist and author, Chi Lo, has no doubt that, in 10 or 15 years, the RMB will be a major global currency.
In his latest book, The Renminbi Rises, Lo says Beijing must first undertake deep reforms to establish the credibility of China’s economic policy. “The question is not about internationalisation of the RMB. The question is about the pace, and how far it can go without an open capital account,” he says.
Peeling away the hype, says Lo, the RMB is currently used in just 0.8 per cent of global trade settlements, according to SWIFT statistics. (China’s central bank, the People’s Bank of China, says RMB trade settlements amounted to  US$330 billion in 2012, nine per cent of China’s total trade.)
To fund trade settlements, the central banks of countries trading with China now hold the Chinese RMB in their baskets of reserve currencies. So far, 30 central banks, mostly in emerging markets and in Africa, hold yuan, says Lo, who is also  Senior Strategist for Greater China with BNP Paribas Investment Partners, based in Hong Kong.
Overall, Lo estimates that the yuan accounts for less than one per cent of total global reserve currencies.
The rise of the yuan has encouraged speculation that the RMB will one day make up one-third of global reserve currencies, alongside the US dollar and the Euro.
Lo says it will not be difficult for the yuan to go from one to four per cent of global reserves, possibly within five years.
Over time, he expects the Chinese currency to erode the importance of the British pound and the Japanese yen in the global basket.
In the international league today, the US dollar makes up 62 per cent, the Euro 25 per cent, the yen and the pound, four per cent each, the Swiss franc, just one per cent, and other currencies, four per cent of reserves.
But any move beyond four per cent for the RMB will depend on how much structural reform is allowed to occur in the Chinese economy, says Lo, not least of all, in making the yuan a convertible currency.
He believes Beijing’s ultimate goal is full convertibility, but the Government needs to have a roadmap. The reason Beijing has no roadmap is because its leaders don’t know how far and fast they can go.
Much of the excitement over a relaxation of control over the currency and some financial services in China in recent months was fanned by a rapid succession of reforms to position the RMB internationally, and to establish an offshore yuan market.  (Hong Kong is the offshore centre for  RMB activities, while Singapore, London and Taipei have ambitions to take on Hong Kong in this space.)
Lo says much of China’s stock market reform was implemented by the previous Chairman of the China Securities and Regulatory Commission, Guo Shuqing. “He was in the job for 18 months and he managed to push through half of the more than 80 changes that he planned,
impacting stock market rules, listing rules, delisting rules, trading, insider dealing, and so on,” says Lo.
“But then he was taken out of the job and posted to provincial government in Shandong. One interpretation of this move is that Guo’s reforms were too drastic, and that they met resistance from vested interests.”
Guo has been replaced by Xiao Gang, a conservative princeling.
In Lo’s eyes, the renminbi faces formidable challenges before it can become a true global currency. “The currency must gain trust. The reason that the US dollar cannot be unseated so easily is because it is transparent, and because the US Government and the US Federal Reserve have credibility,” he says.
He believes China will have to reform its bond market, fully liberalise interest and deposit rates, and improve its stock markets for this to occur.
China’s shadow banking market also needs to be brought under the control of the regulators, says Lo. China’s total credit today is 200 per cent of GDP. “It is very high, but not fatal.”  
China has said it is reviewing its one-child policy and the system of hukou (household registration). These are written into the Chinese constitution, and change will not come easily.
The Central Government wants to push urbanisation — it is the right thing to do, Lo says — to increase the urban population, and this will lead to higher investment, income growth and consumption.
“But it is complicated because it involves local authorities, which do not have enough resources to fund urbanisation. They are not allowed to raise money from the bond market,” says Lo. A handful of provinces are now allowed — with approval — to launch bond issues.
At around 45 per cent, China has one of the world’s highest investment ratios, but an increasing amount of investment is wasted on white elephant projects or unproductive projects, Lo says.
This investment is driven by cashed-up State-owned enterprises (SOEs), which have access to cheap bank financing, whereas the private sector is unable to get bank loans. “It is a dichotomised situation — excessive and bad investment in one part of the economy while the other part is deprived of credit.”
Lo says it is only implicit Government guarantees which are holding up China’s banks and stopping big corporates from loan defaults. “This kind of distortion can only go on for X number of years before it gets to a boiling point. It is not sustainable.”
Chinese authorities recognise the need to reform the financial system, and to end the system of rent-seeking. But their task is becoming harder as vested interests become more entrenched, he says.
These groups were previously ardent reformers themselves. Reform delivered wealth and influence. “Now that they are very rich, they want to protect their wealth. Further reforms will hurt their wealth, so many now resist them.”