1. International Use of the Renminbi: Developments and Prospects
Conference on
The BRICS & Asia, Currency Internationalization,
and International Monetary Reform
Hong Kong, December 2012
International Use of the Renminbi: Developments and Prospects
Dong HE (何東)
Executive Director (Research), Hong Kong Monetary Authority
Director, Hong Kong Institute for Monetary Research
* The views expressed here do not necessarily represent those of the HKMA or the HKIMR

2. Questions to address
What is the macroeconomic and financial market context in facilitating the international use of the renminbi?
What are the infrastructure requirements that need to be put in place for the renminbi to be used for cross-border trade and investment?
Why do non-Chinese residents have incentives to hold renminbi-denominated assets and liabilities? How do they acquire renminbi-denominated assets and liabilities?
Is renminbi internationalisation compatible with the gradualist approach to capital account liberalisation?
What’s the progress? Where do we go from here?

3. Outline of presentation
The context
The role of official policies
Incentives
The role of offshore markets
Prospects

4. The context
The “dollar shortage” during the trans-Atlantic financial crisis of highlighted the danger of relying excessively on one reserve currency in international trade and payments, and the possible benefits of using a wider array of currencies, including emerging market currencies, especially in transactions between emerging markets
More broadly, the spread of the crisis globally was seen as an intrinsic defect of the international monetary system, where domestic policy objectives of the major reserve currency country override its obligations to maintain global monetary and financial stability
I will speak mainly on two issues: first, elements of the post-crisis global and regional order; and secondly, what does this new order mean for Hong Kong as an international financial centre.

5. The role of official policies
Whether or not a currency is used extensively for international transactions is primarily determined by market forces
Renminbi internationalisation is more a process of dismantling extant restrictions against its international use, rather than active promotion
Since mid-2009, the Chinese authorities have moved quickly to remove restrictions against the use of renminbi in current account transactions, and have gradually expanded the scope for the use of renminbi in capital account transactions
The main challenge in managing the process is to delineate the relationship between currency internationalisation and capital account liberalisation
Currency internationalisation is seen as an integral component of the broad financial sector reform and development agenda, and can be made consistent with the Chinese approach to capital account liberalisation

6. Capital account liberalization with Chinese characteristics
“Proactive, controllable, and gradualist”
Sector- or location-specific policy experiments
“Quick small steps”
“Speed bumpers”
The degree of convertibility of the renminbi is best seen as a spectrum, not black or white

7. Preconditions for international use of currencies
Except for non-deliverable markets, international use of currencies is impossible without the cooperation of onshore banks
Cross-border use of currencies is an international financial transaction and requires some degree of non-resident convertibility
Offshore banks need to be able to keep and have access to clearing balances with onshore banks

8. Special arrangement in Hong Kong
Before July 2009, offshore banks generally could not maintain and have access to renminbi balances kept with onshore banks
Hong Kong was the first place outside Mainland China to provide renminbi banking services since 2004
For renminbi banking in Hong Kong, a “Clearing Bank” was appointed by the People’s Bank of China (PBoC) in late 2003 to be the conduit, which
accepts deposits from participating Hong Kong banks and in turn maintains balances with PBoC
acts as the counterparty of currency exchange transactions of the participating banks and in turn squares its own positions in the China Foreign Exchange Trading System in Shanghai

9. Non-resident convertibility further expanded in 2009 and 2010
With the launch of pilot scheme of RMB trade settlement in July 2009, overseas banks could open correspondent accounts with banks inside China
From August 2010 overseas nonbank institutions accepting payments for exports to China in renminbi can deposit the proceeds from such transactions on accounts with banks inside China

10. Sources and uses of renminbi funds
Outflows from China
Payments in renminbi for imports by Chinese firms
Payments in renminbi for outbound direct investment (ODI) by Chinese firms
Banks make loans to overseas firms in renminbi
Onshore banks make loans to offshore banks in renminbi
Swap lines with foreign central banks
Inflows to China
Payments in renminbi for imports from China
Payments in renminbi for FDI investment inside China
Repatriation of renminbi proceeds from bonds issued overseas by Chinese banks and firms, subject to approval
Investment in the interbank bond market by foreign central banks and commercial banks which provide renminbi trade settlement services, subject to approval and quota
Investment in the bond and equity market by Qualified Foreign Institutional Investors (R-QFII), subject to approval and quota

11. Incentives (I)
Market forces have responded quickly to official policies
Non-Chinese residents have strong incentives to increase their exposure to renminbi assets and liabilities because the starting positions are in all likelihood significantly below their desired or optimal portfolio allocations in the renminbi
Such optimal allocations are likely to grow with the increasing weight of the Chinese economy in global production and trade
The underlying incentive to increase exposure to renminbi assets and liabilities by non-Chinese residents is likely to have an upward trend, not easily reversed by cyclical fluctuations in exchange rate expectations

12. Incentives (II)
From the Chinese residents’ point of view, the use of renminbi for trade invoicing and settlement allows Chinese firms and their counterparts to better share risks
Internationalising the renminbi can also be expected to reduce currency mismatch of China’s international balance sheet
An internationalised renminbi would allow governments and firms outside China to borrow in renminbi and thereby allow Chinese life insurers and pension funds to diversify credit while matching renminbi liabilities

13. Why do offshore markets exist?
Offshore markets play essential economic functions even when capital can flow freely across the border (He and McCauley (2010))
Separation of currency risk from country risk
Convenience factors (legal systems, accounting standards, language, time zone/geography)
Diversification of operational risk
Even nowadays, when foreigners use the US dollar to settle trade and make investments, they concentrate their transactions in international financial centres such as the euro-dollar markets in London, not onshore in New York City
In fact, one may argue that without the offshore markets, the US dollar would not probably have attained as dominant a position in international trade and payments as it occupies today

14. Hong Kong as a renminbi offshore centre
Hong Kong was the first place outside Mainland China to provide renminbi banking services since 2004
Because of the willingness and ability of Hong Kong monetary and regulatory authorities to cooperate closely with their counterparts on the Mainland, Hong Kong is the ideal offshore jurisdiction to provide a reliable testing ground for the international use of the renminbi
Gradual and steady expansion of business scope, markets and products

15. The CNH market in Hong Kong
Since July 2010, Hong Kong has produced a second set of spot and forward exchange rates for the renminbi, dubbed the CNH, for delivery of renminbi against dollars outside Mainland China
A second set of renminbi yield curves has also been formed in Hong Kong with the active issuance of bonds by the Chinese Ministry of Finance and firms from both inside and outside China
These offshore renminbi exchange and interest rates have retained a spread over but have tended to move in tandem with onshore rates

16. Size of the renminbi forex market in Hong Kong
Payment versus Payment (PvP) in the RMB RTGS system
RMB 15 billion average daily turnover in H1 2012
There are however other forex transactions not reflected in PvP turnover; the actual size of the RMB forex market in Hong Kong is probably twice as large as the PvP figure of RMB 15 billion per day
Efficient clearing and settlement systems, seamless interface with Mainland’s CNAPS
PvP settlement device eliminates FX settlement risk for banks

17. Capital account liberalisation and renminbi fund flows in offshore markets
At present, the renminbi balance sheet of banks in Hong Kong serves as a conduit for net renminbi lending from the rest of the world to the mainland. Renminbi bonds issued by non-banks and held outside the banking system tend also to result in a net renminbi claim of the rest of the world on China
Looking forward, capital flows can be expected to become two-way and more balanced with capital account liberalisation (He et al (2012))
The expected path of the renminbi exchange rate shows much less consistent appreciation, even as the Chinese current account surplus has narrowed. Thus, non-resident borrowing in the renminbi looks to be less discouraged by one-way expectations on the exchange rate
In this case, the renminbi offshore markets in Hong Kong and in other centres can be expected to evolve along the paths of the other types of offshore markets. Over time, the renminbi offshore market is likely to play above all the role of intermediary between non-mainland Chinese borrowers and lenders
I will speak mainly on two issues: first, elements of the post-crisis global and regional order; and secondly, what does this new order mean for Hong Kong as an international financial centre.

18. How would offshore renminbi markets evolve?
My colleagues also estimated a gravity model to analyze how the bilateral portfolio investments are determined among the OECD countries. Based on the results of the estimated gravity model, we can compare the relative attractiveness of different economies in competing for portfolio investment flows from China.
The way to look at the chart: market capitalisation on Vertical axis, distance of each country from China on Horizontal axis; share of portfolio investment from China captured by each country represented by the size of bubbles; for ease to look at the ranking - darker colour denotes larger share captured.
Based on projections from our model estimates, it is expected that Hong Kong is able to capture a significant share of China’s portfolio investment (over 9%), while a major portion would be invested in the US, Japan and UK, which have a combined share of around 75% of global stock market capitalisation.
Source: He and McCauley (2012)

19. How fast will it go?
The Mainland authorities are likely to proceed steadily and will strive to achieve a good balance between containing potential risks on the one hand and reaping the benefits of wider international use of the renminbi on the other
They are likely to manage the pace of the international use of the renminbi so that it is consistent with their overall approach to captial account liberalisation, and maintain a “spectrum of convertibility” of the renminbi

20. Will the renminbi become a widely used international currency?
In the long run, the status of the renminbi as an international currency will depend on the size of the Chinese economy and the sophistication of renminbi financial markets
As long as Chinese economy keeps a fast pace of growth and further integrates with the global economy, the prospect of the renminbi is bright
The status of the renminbi as a global reserve currency will also depend on China’s ability to transform the structure of its international balance sheet
It needs to master the technology of providing liquidity service by issuing short-term liabilities to non-residents while at the same time making productive claims on non-residents

21. Concluding remarks (I)
Large potential of trade and investment flows between emerging market economies provides a good opportunity for these economies to use their own currencies for such cross-border transactions
Wider use of the renminbi in cross-border trade and investment will allow Chinese residents to share risks with their overseas counterparts
Facilitating the international use of the renminbi requires a deliberate pace of institutional reforms and policy liberalisation, which in turn would be conducive to a more open and market-based financial system in China

22. Concluding remarks (II)
The pace of financial system reform and capital account liberalisation in China is set to accelerate in the next five years
How quickly will it go? Not too fast, not too slow
Hong Kong is well positioned to benefit from the process as the premier offshore renminbi centre

23. Thank you for your attention!
End of presentation
Thank you for your attention!