China’s Renminbi Conundrum

China’s tentative efforts to promote the international use of the renminbi are clashing with its desire to avoid exchange rate instability.


When government officials last year authorized Sassin International Electric Shanghai Co. to bill its exports in renminbi instead of dollars as part of a trial program aimed at boosting international use of the Chinese currency, company executives were delighted. The Shanghai-based maker of low-voltage circuit breakers exported the vast majority of its $50 million in sales in 2008. Invoicing customers in renminbi could save the company banking fees and eliminate the risk of currency losses. “We look forward to the day when renminbi is widely used globally,” says David Dong, director of international sales at Sassin.

Dong is still looking. Several months after Sassin gained that authorization, back in July 2009, the company hasn’t issued a single invoice in renminbi and doesn’t know when it will. Tight restrictions on the renminbi program as well as other constraints on what foreigners can do with the currency have severely limited the ability of the 365 companies authorized under the program to actually take advantage of the liberalization measure. For instance, China allows the companies to issue renminbi invoices only to customers in the Chinese-controlled territories of Hong Kong and Macao and the ten member states of the Association of Southeast Asian Nations. Sassin, however, exports primarily to companies in Europe, Japan and the U.S. “So far we haven’t issued any invoices in renminbi, but we hope to do so someday,” says Dong.

At a time when U.S. and European officials are urging Beijing to loosen currency controls and allow the yuan to appreciate to reduce trade imbalances, Sassin’s story is a cautionary tale about the prospects of early liberalization. Government officials say they want to move toward currency convertibility and have adopted some programs designed to increase the international use of the renminbi, or the yuan as it’s also known, but in practice they continue to keep the currency under very tight control. Officials fear the threat of currency instability, which they saw ravage many Asian countries during the region’s financial crisis in the late 1990s. They also don’t want to do anything to undermine the country’s massive export machine, which continues to drive the economy. It’s instructive that after two years of liberalization that saw the renminbi appreciate by 18 percent against the dollar, Beijing reversed policy and effectively restored a fixed exchange rate in August 2008, just as the global financial crisis was moving to its peak and sending much of the world economy into a sharp recession.

“China is serious in making the RMB a global currency, but it will not be timely,” says Derek Scissors, a research fellow and longtime China watcher at the Heritage Foundation in Washington. “We’re presently on a 20-year pace, if that. It’s hard to be any more optimistic when the biggest recent move was negative — the tightening of the peg.”

The invoicing program is far from an isolated example. China’s recent history of financial liberalization is checkered at best. The government has a habit of announcing supposedly bold initiatives to free up financial markets, only to fail to follow through, or let some experiments wither on the vine. In August 2007 officials announced a plan to allow Chinese individuals to invest directly in Hong Kong stocks through a new financial zone in Tianjin, a northern port city near Beijing. The government never implemented the program, however, because Premier Wen Jiabao was afraid of capital flight, sources say. A little over a year later, in October 2008, the government announced plans to introduce margin trading of stocks and short-selling on an experimental basis. The China Securities and Regulatory Commission even went so far as to request license applications from a select number of firms in Shanghai in January 2009, but the regulator never got around to actually granting any licenses. “Officials were afraid that implementing margin trading and shorting would hurt China’s stock markets,” says one official, who spoke on condition of anonymity. “The experiment isn’t dead; it’s just not being implemented.”

“The current set of senior leaders obviously does not have the courage or interest to move toward the market,” says Scissors. “They have moved away.” He points to the government’s 4 trillion yuan ($585 billion) stimulus package, adopted in late 2008. Although the program has succeeded in getting the growth rate back above 8 percent, a vital prerequisite for maintaining job growth and social stability, most of the funds have been channeled through state-owned banks and benefited state-owned companies rather than private firms.


Notwithstanding officialdom’s concerns, the government has taken other steps recently to increase the use of its currency, sustaining hopes of a rising volume of renminbi-based business. Over the past year the authorities have announced the creation of $95 billion worth of currency swap agreements with six trade partners: Argentina, Belarus, Hong Kong, Indonesia, Malaysia and South Korea.

“China is setting up direct trade accounts with many nations, and the list of countries will continue to grow in the future,” says Peter Wong, chairman of the Hong Kong Association of Banks and executive director of Hongkong and Shanghai Banking Corp., HSBC Holdings’ main Hong Kong subsidiary. “You can see China pushing the renminbi going forward to being internationalized.”

The government also eased currency controls on people in Hong Kong in 2007. This move allowed individuals to buy as much as 20,000 yuan a day and send up to 80,000 yuan a day into China without having to seek approval from the State Administration of Foreign Exchange, the central bank arm that manages China’s $2.27 trillion in foreign exchange reserves. The government also allows Hong Kong residents to remit renminbi from accounts in China back to Hong Kong as long as they can prove that the money was not derived from investment gains made in China.

At the end of September, Hong Kong residents held about 58 billion yuan in deposits in local banks, the only significant pool of yuan outside the mainland. Many residents are keen to build up yuan savings, betting that Beijing will let the currency appreciate in the years ahead.

These savings, in turn, are helping to foster the beginnings of a yuan-based capital market in Hong Kong. Since 2007, Chinese companies have raised a total of 38 billion yuan through 11 bond issues in the territory. China’s Ministry of Finance sold 6 billion yuan of 2.25 percent, three-year bonds in Hong Kong in October. It was the government’s first debt issue outside the mainland, and it demonstrated the authorities’ determination to internationalize their currency, even if only gradually. In June, HSBC Bank (China) Co., a subsidiary of the global bank, raised 1 billion yuan by selling a two-year floating-rate note priced at 38 basis points over the three-month Shanghai interbank offered rate.

Such bond issues should help develop the renminbi market in Hong Kong and encourage the internationalization of the currency, says Tomo Kinoshita, deputy head of economics for non-Japan Asia at Nomura International (Hong Kong). As liquidity grows, banks will want to develop yuan forward and swap instruments. “Currency hedging is a key factor in ensuring the wide take-up of the renminbi settlement system, in our view, and an essential step if renminbi is to become an internationalized currency,” he says.

Meanwhile, the renminbi invoicing experiment is proceeding, but at a slow pace.

Standard Chartered Bank, which along with HSBC, its Hang Seng Bank subsidiary and Japan’s Mizuho Corporate Bank are the only foreign banks allowed to conduct renminbi trade settlements, has handled a number of modest deals since the invoicing program was launched. The bank helped trading company Chapman International Macao Commercial Offshore to pay 60,639 yuan to Dongguan Ming Hoi Dyeing and Finishing Fty Co. It also handled a 200,000 yuan payment from NewOcean Energy Holdings, a Hong Kong-based distributor of liquefied petroleum gas, to its China subsidiary, NewOcean Energy (Zhuhai) Co.

Most of the yuan deals that the bank has handled have involved trade between Hong Kong–registered companies and their subsidiaries on the mainland, according to Neil Daswani, head of transaction banking for the Greater China area. “It’s still early days, but we can confirm the settlement mechanisms work smoothly,” he says.

The general manager of a Hong Kong–based concern that operates factories in Dongguan that make furniture for western retailers such as Sweden’s Ikea says his company has settled some invoices in renminbi even though the program has little attraction for his business. “We’re doing this as a favor,” says the executive, who spoke on condition that he and his company not be identified by name. “The Chinese government wants this experiment, so we’re helping out. But to be honest, we’re not benefiting from this. Our clients are mostly in Europe, and we’re not sure when — or if ever — the government will allow Europeans to pay in renminbi.” Moreover, none of the company’s customers in the U.S. or Europe wish to pay in renminbi, he adds.

Executives at leading Chinese banks declined to comment on the invoicing program, with some citing the political sensitivity of the subject. Six domestic banks have been approved to handle renminbi trade settlement, including Bank of China, Bank of Communications Co., China Construction Bank Corp., China Merchants Bank Co., Industrial and Commercial Bank of China and Shanghai Pudong Development Bank Co.

Most of the companies authorized to issue export invoices in renminbi are small and medium-size companies with annual sales under $100 million. Officials are taking applications from other exporters as they prepare to expand the experiment to as many as 10,000 companies, according to Chinese exporters that are applying to participate in the program.

“We hope the experiment will be accelerated,” says Linda Luo, a spokesperson for JinPin Electrical Co., a Zhuhai-based maker of liquid-crystal-display television screens that was among the first group of companies authorized to issue renminbi invoices, but, like Sassin, hasn’t yet done so. “We hope to receive renminbi for all of our exports, and we also hope the Chinese government will end all capital exchange controls.”

Translating that potential interest into actual renminbi-based trade won’t be easy, though, judging by the experience to date. For one thing, the small number of nations covered by the program is a factor limiting the use of the renminbi, bankers and exporters say. The Asean countries involved in the experiment accounted for only 9 percent of China’s two-way trade of $2.6 trillion in 2008.

Foreign manufacturers operating in China point out that restrictions on foreign investments in China’s capital markets discourage them from billing in yuan and accumulating large yuan reserves. “What do we do if we accumulate a large amount of sales proceeds in yuan?” asks a Hong Kong–based exporter who operates factories in Guangdong and who asked not to be identified by name. “We can’t quickly convert large amounts into other currencies, because of exchange controls.”

And therein lies the rub. As long as China maintains capital controls, minor liberalization efforts are not likely to gain traction.

“Internationalizing a country’s currency in the absence of capital account liberalization is extremely difficult,” says Ha Jiming, chief economist for Beijing-based China International Capital Corp. “RMB trade settlement requires that there is a large amount of RMB outside China, but that is not the case. China would naturally wish to settle imports in RMB to maximize seigniorage, but why would foreign exporters based in China accept RMB if they cannot freely invest the proceeds back into China?”

Currently, Hong Kong–based exporters can invest renminbi in China only after gaining approval from the authorities to bring the money into the country. If they keep it in a Hong Kong savings account, they will earn interest of just 0.75 percent a year, far less than the 2.25 percent deposit rate in China.

Yifan Hu, global chief economist for Hong Kong–based Citic Securities International Co., says it is too early to judge the invoicing program. “We do not expect the pilot program to go too fast, particularly given that global demand remains weak. However, we do expect the demand in renminbi trade settlement to rise in 2010.” She believes China could settle as much as half of its trade in renminbi in the coming years.

One reason for optimism among convertibility advocates is the government’s declaration in June that it aims to make Shanghai a global financial center by 2020. Beijing can’t achieve that goal while maintaining capital controls, says HSBC’s Wong.

Stephen Roach, chairman of Morgan Stanley in Asia, agrees. “China is gradually moving in a clear direction. The end game is a convertible and free-floating currency,” he says. “The State Council objective is to make Shanghai a financial center by 2020. It clearly puts a stake in a ground on what is expected in financial reforms. When China lays out a target with that much clarity, they will do their best to hit it on time.”

China’s definition of a financial center may be different than what Westerners have in mind, cautions the Heritage Foundation’s Scissors. “I suspect that the current Party leadership has a different view of ‘global financial center’ — a global financial center with Chinese characteristics. For example, there will be a large and partly internationalized stock market, but with its access — and attractiveness — still curtailed to prevent rapid sell-offs by foreign institutions.”

The clash of goals is summed up by Guan Anping, a Beijing-based securities lawyer and onetime legal aide to former minister of Foreign Trade Wu Yi. He contends that the government is determined to create an exchange system that is as risk-free as possible and isn’t prone to hedge fund onslaughts. “China will reform its exchange mechanisms,” Guan says. “It’ll be step by step and may appear to be slow at times, but this way the government will be able to keep things under control.”