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China Economic Reform

Next step for RMB internationalization

Xinhua Finance | Fri,2016-09-23

The People’s Bank of China (PBOC), or the central bank, announced yesterday that it authorizes Bank of China, New York branch as clearing bank of RMB business in the U.S.

Previously, Industrial and Commercial Bank of China, Canada branch acted as clearing bank of RMB business in Toronto, Canada. RMB clearing bank basically covered all time zones but failed to build branch in the U.S., the biggest economy in the world. 

This is another big step for RMB internationalization. RMB will be officially included in Special Drawing Right (SDR) on Oct. 1. Where has the RMB internationalization arrived now and where will it move towards in the future? What is the impetus of overseas entities holding RMB assets when RMB does not tend to appreciate anymore? 

Yield rate of RMB assets is still appealing, but the central bank began to liberate interbank bond market and foreign exchange market to overseas central banks and qualified investors since last year, said Zhou Chengjun, deputy director of monetary policy of the central bank, at the Silk Road Financial Forum yesterday. There is demand for risk hedging, currency management and even profit taking after investors enter the market. RMB can be not only used as investment currency and reserve currency but also used international financial transaction currency. This should be the meaning of policy framework for RMB internationalization in next stage.

When no trend for RMB appreciation anymore 

Why do overseas subjects hold RMB? If before the first half of 2014, the answer would be the RMB appreciation in the long and medium term. After joining in the World Trade Organization (WTO) in 2001, China became the biggest goods trade country in the world in a short period. During this period, China has accumulated a great deal of foreign exchange reserves, which amounts to nearly 4 trillion US dollars at its most. RMB has undergone a process with slow but “continuous and solid” appreciation. 

At that time, value of RMB still increased even when overseas investors only kept the RMB assets under their pillow. But the long-term RMB appreciation trend changed from the second half of 2014. There was once very strong expectation on RMB devaluation after exchange rate reform on Aug. 11 last year. Are there any reasons for overseas subjects holding RMB assets now? 

As for this question, Zhou responded that “According to statistics from Society for Worldwide Interbank Financial Telecommunication (SWIFT), international acceptance level of RMB grew from about 18 percent two years ago to more than 36 percent as of late May. This means that although there is expectation and tendency of RMB devaluation in recent two years and some institutions even do short selling of RMB, RMB is still doubly accepted internationally.”

So what is the purpose of market entities accepting, investing and holding RMB assets? A group of data comparison may explain this. Japanese 10-year government bond yield rose to zero yesterday for the first time over the past three months, while it was always negative before, so did the 10-year government bond yields of Germany and French. 10-year government bond yield of the UK fell to below 1 percent after Brexit voting, while that of the US stayed at about 1.6-1.7 percent. 

According to statistics from China Central Depository & Clearing Co., Ltd. (CCDC), 10-year government bond yield of China was 2.75 percent on Sept. 21, and yield of local government bond issued by some provincial-level government with better qualification was above 3 percent. This indicates that overseas institutional investors can enjoy above 3 percent risk-free yield if investing in Chinese interbank bond market. 

This can explain why the central bank carried out a series of measures opening financial market since last year. Overseas central banks are allowed to use RMB to invest in interbank bond market without any restriction over access, quota and transaction products in last July. The PBOC liberated interbank exchange rate market to overseas central bank in September 2015 and opened access of interbank bond market to global qualified institutional investors in February this year. 

Zhou put it bluntly that “even if the upward trend of RMB is reversed, overseas non-residents holding RMB-denominated assets can still share the achievements of China’s economic growth”.

Profit-taking channels for overseas investors

RMB will officially enter the International Monetary Fund (IMF)'s SDR currency basket on Oct. 1. It means that theoretically, both the IMF and its 189 member countries recognize the role of RMB as reserve currency.

At present, the reserve assets held by global central banks total around 11.46 trillion US dollars with RMB-denominated reserve assets only accounting for 1.13 percent. Zhou estimated that after the inclusion of RMB into the SDR, the RMB-denominated reserve assets purchased by central banks alone will drive up the ratio to above 4 percent in a short time.

The trusteed bonds in China’s inter-bank market records around 70 trillion yuan with the proportion of bond balance held by non-residents lower than 1 percent. According to the IMF’s research, overseas non-residents usually hold 10-20 percent of the bonds in most of the developed countries and emerging markets.

The 2016 RMB Internationalization Report points out that after RMB enters SDR, foreign investors will become more confident about RMB and show stronger willingness to hold RMB-denominated assets.

Thus, RMB might develop into investment currency and reserve currency. Is this the end of RMB internalization? It is not, according to Zhou.

Investment means purchasing and selling. In the eyes of Zhou, “rational investors will surely take profit-taking into consideration when making investment decisions, so we should provide investors with opportunities for profit-taking. Currency management, risk matching and hedging channels must be in place when investors change their expectation or they have other plans for liquidity. Becoming international investment/reserve currency is not the final goal of RMB internationalization. For the next step, RMB aims to become international financial transaction currency. It means that we should further advance capital account convertibility, further open financial market, enable domestic investors to get involved in international foreign exchange market, and welcome overseas investors to participate in our own foreign exchange market. This is the aim of RMB internationalization policy framework for the next step and it throws out challenges to the central bank.”