Implications of Renminbi Internationalisation for Australian Exporters
Roger Donnelly, Chief Economist | Fred Gibson, Economist
9 March 2016
We ask two questions in this paper.
- How is RMB internationalisation (RMBI) going? (How has it proceeded so far? How much further has it to go? What might it culminate in?)
- How are Australian companies responding? (We concentrate on exporters, but also consider importers and direct investors. We ignore portfolio investors, because as important as they are, they are beyond the scope of our paper.)
Our answers are
- Internationalisation is going quickly, though from a low base. The RMB has gone from being the 35th most used currency to settle international payments in 2010 to No. 4 in 2015. It has also come to be used extensively to settle FDI transactions—both out of China and into it. For other purposes, it is much less widely used and traded, held back by Chinese capital controls and backward financial markets. There is scope for the RMB to become much more widely used and traded if these hindrances are removed. Then we are likely to see much more foreign portfolio investment in RMB assets and much more cross-border RMB lending. Will the RMB come to dominate the international financial system in the way the USD was dominant in the second half of the 20th century? That seems less likely than that the RMB will entrench its place among the world’s most important ‘freely usable currencies’, behind the USD, but alongside the EUR, JPY, GBP, CHF, AUD and CAD.
- Australian companies are responding slowly, though the pace is starting to pick up. Surveys suggest RMB invoicing and settlement of Australian trade with China has risen from nothing in 2009, when Beijing first allowed it, to the point where 37% of Australian companies asked in one 2014 survey said they had experimented with RMB terms. What's more, there is scope for such a switch to go further, because of the mutual profit to be reaped. Australian exporters and importers can hedge currency risk more cheaply than can their Chinese trading partners, because Australians have access to the more developed offshore RMB, or ‘CNH’, market, while Chinese traders must generally make do with the less developed onshore, or ‘CNY’, market. Therefore it can pay the Australian partner to bear the currency risk, encouraging the Chinese partner to offer in return a price premium or discount. Provided the premium or discount is between the cost of hedging for the Chinese and Australian party, both will benefit. Unfamiliarity with RMB invoicing and settlement is preventing many of these ‘free lunches’ from being eaten at the moment, but free lunches are seldom ignored indefinitely.
The place to look for a major switch to RMB terms is the commodities trade. This has traditionally been done on USD terms—and still is. It is the large value of this trade plus its conduct in USD that has held back the overall adoption of RMB terms in Sino-Australian trade. Yet ‘China Inc’ is now pushing for such an adoption with many trading partners, including Australia. And Brazilian and Australian miners are reportedly weighing up the pros and cons of a switch.
In other areas, Australian adoption of the RMB has been much less extensive. For instance, few if any long term export credit deals are on RMB terms. The chief reason seems to be that both Australian exporters and Chinese importers are comfortable with existing USD, EUR and JPY facilities. Still, it seems probable that demand for RMB credit will soon emerge. In that event, banks could have difficulty meeting the demand, because of two constraints: first, difficulty borrowing large sums of RMB for longer than three years; and second, a probably limited risk appetite for Chinese counterparties at longer tenors. It will be interesting to see how they respond to these constraints in seeking to meet the demand.
Two underlying impulses of RMBI can be identified. The first is China's accession to the WTO in 2001. This spurred a decade of rapid development in which China became the world’s second largest economy, and its premier trading nation, growth engine, saver, and official foreign reserve holder. If there had been few restrictions on international use of the RMB in 2001, it is likely that RMBI would have grown in line with China's growing weight in the world economy. But the restrictions were actually many, and stifled the internationalisation.
But then the financial crash came along in 2008, providing the second impulse for RMBI. The crash highlighted for Beijing the risk of dependence on the US dollar, and prompted it to begin loosening restrictions to encourage internationalisation. Its efforts had considerable success. Use of the RMB in international transactions—for trade invoicing and settlement, for inward and outward investment, for RMB financing in all its forms, for portfolio investment, for currency swaps, and in the offshore RMB market—has been rising rapidly since 2010. In fact, the RMB overtook the yen last year to become the fourth most used currency in international transactions. So RMBI is now catching up with China’s position as a saving and trading dynamo.
What is internationalisation?
Before we start our analysis, we clarify what we mean by RMBI. Basically, it is a process that establishes what the IMF calls a ‘freely usable currency’. 
And what is such a currency? The Fund defines it as one both ‘widely used to make payments for international transactions and widely traded in the principal exchange markets’.
As for the international transactions that a freely usable currency expedites, these include both ‘current account’ and ‘capital account’ transactions.
Current account transactions are those involving the purchase and sale of goods and services, the remittance of labour and capital income, and the making of unrequited transfers such as workers’ remittances and foreign aid payments. Capital account transactions are those involving inward and outward portfolio and direct investment and the purchase and sale of official reserve assets.
How does internationalisation differ from capital account convertibility and reserve currency status?
The second thing we need to do is distinguish between RMBI, capital account convertibility and reserve currency status—terms that are often used interchangeably, yet mean different things.
Internationalisation we have already defined—a process that spawns a freely usable currency.
Capital account convertibility (aka an open capital account) refers to a situation where no restrictions impede cross-border capital flows.
Reserve currency status is reached when a currency is held by foreign central banks as protection against balance of payments crises.
Notice that capital account convertibility doesn't guarantee that a currency becomes freely usable—consider, for instance, Denmark or Norway or Singapore. And nor does a freely usable currency require a fully open capital account—just look at China.
But both free usability and an open capital account are necessary for a currency to become a reserve currency.
What’s the SDR got to do with it?
The final preliminary thing we quickly consider is the SDR, or special drawing right.
Last December, the IMF decided to include the RMB in the basket of currencies that makes up the SDR, alongside the USD, EUR and JPY. The SDR is an international reserve asset created by the Fund to supplement its members’ official reserves.
Some commentators thought this was momentous. Neil Irwin wrote in the New York Times that the move was like ‘what happened about a century ago, when the United States dollar was gradually supplanting the British pound as the predominant currency’, and ‘was a crucial piece of the nation’s rise to superpower status’. Similarly, Matt O'Brien in the Washington Post wondered whether China ‘might be like the U.S. 100 years ago’—about to displace America as the world's financial superpower, just as America displaced Britain afer the First World War. 
But that view looks mistaken. Under IMF rules, governments can exchange their holdings of SDRs for freely usable currencies held by other governments, if they are suffering a reserve shortfall and wish to defend their exchange rates. What the Fund has now decided is to include the RMB in the basket of currencies used to value the SDR. This seems ‘not much more than a minor change in accounting, with trivial economic implications’, as the economist Paul Krugman has observed—rather than something that will catapult the RMB to currency superpower status. As such, we dismiss it from further consideration in this paper.
1. How is internationalistion going?
Rapidly, though from a low base
As we note above, internationalisation seems to be going quickly, though from a low base. Which means it has now reached quite an advanced level.
What is striking is how recently the RMB was hardly used at all internationally. In 2010, it was only the 35th most used currency to settle payments. Yet since 2011 its use has grown rapidly. According to Standard Chartered, international use of the RMB grew at an average of nearly 7% pa over 2011-14 (Chart 1). And according to SWIFT, the RMB overtook the JPY last year to become the world's fourth most used payments currency. It overtook the Canadian and Australian dollars in 2013 (Chart 2).
‘The RMB has gone from being a currency largely unusable outside China a few years ago to the fourth most heavily used in global payment transactions – just after the British pound’.Institute of International Finance, ‘China Spotlight: What Next for Renminbi Interrnationalization?’, October 29, 2015
This index is a measure of the latest trends, size and levels of offshore activity driving adoption of the RMB as in international currency.
The second striking feature of RMBI is its differential adoption.
The RMB is now widely used in trade invoicing and settlement, and for direct investment settlement.
- Close to 20% of China’s goods trade is now settled in RMB—and almost 25% of other current account transactions—services, interest and dividend payments.
- Close to 30% of FDI transactions were settled in RMB in 2014, up from 13% in 2012.
- And close to 16% of China’s outward direct investment is now settled in RMB, up from just 4% in 2012.
All it took to trigger this adoption were decisions by the authorities to allow use of the RMB for trade settlement in 2009 and direct investment settlement in 2011.
But for other purposes, the RMB is much less widely used and traded. Take official foreign currency assets, international banking liabilities, international debt securities (IDS) outstanding, issuance of IDS, SWIFT cross-border payments, and daily FX turnover. The RMB share of each of these is less than 2% (Charts 3-4). Even the RMB share of worldwide trade finance is only 4%, a figure much lower than its share of the settlement of China’s foreign trade (Chart 5). 
What about medium and long-term export and project finance? After all, the major Chinese development banks and export credit agencies (ECAs) like China Eximbank and China Development Bank now extend large volumes of long term credit worldwide—according to one estimate, US$101b in 2014. (Meanwhile, OECD ECAs extended US$97b.)  Surely a proportion of this, perhaps a growing one, is done in RMB? Actually, all the data suggest this isn’t so. Have other ECAs started to extend RMB credit? Hardly at all. The only such deal that we know of is a guarantee from UK Export Finance. It supported a RMB buyer credit that helped finance the purchase of an Airbus by a Chinese airline.
But there are two things to bear in mind when interpreting these numbers. First, they are somewhat dated. Second, RMB use and trading is undergoing rapid growth in many fields. For instance, BIS data on the RMB share of FX turnover go up to only early 2013. Yet SWIFT data based on inter-bank messages used to confirm FX transactions show a 100% increase in RMB turnover between the March quarter of 2013 and the March quarter of 2015. 
To sum up: cross-border transactions are heavily skewed towards the seven established freely usable currencies—the USD, EUR, JPY, GBP, CHF, AUD and CAD. An 80:20 rule is in evidence, where loosely speaking 20% of currencies are used for 80% of transactions, and 80% of currencies are used for 20% of transactions. But this existing distribution is coming under challenge from the RMB. It is moving up from the tail of the distribution of currencies and shows promise of joining the major freely usable currencies.
How much further has RMBI to go? And what might it culminate in? Will the RMB eventually rule? That is one way the question is often put. 
It follows from our previous analysis that RMBI could certainly go further. First of all, the RMB is little used as a funding currency. Second, RMB positions among international banking liabilities and debt securities are minimal. Third, the RMB has made it to reserve currency status, but again only minimally so.
The hindrances to its greater use seem to be two-fold. First, Chinese capital controls that restrict inflows and outflows of capital. These prevent would-be buyers and sellers of RMB assets from trading. The second hindrance is a lack of financial development that reduces the attractiveness of RMB assets to foreign investors, both private and official. It arises because Chinese financial markets lack depth and liquidity—not to mention adequate transparency, corporate governance, contract enforcement, and rule of law. These factors deter foreign investors from buying RMB assets in the first place.
The implication is that if greater capital account liberalisation and financial development are forthcoming, further currency internationalisation will follow, particularly in the areas where it is lagging. But it is difficult to predict how quickly these reforms will happen. We know the Chinese want to make the RMB a freely usable currency. But we also know they don’t want to reap a whirlwind through rushed reform. The first impulse pushes them forward; the second holds them back. The result of this push and pull is hard to fathom.
For instance, if they liberalise the capital account they will need to accept more exchange rate flexibility and remove interest rate controls. Greater currency flexibility is needed to allow the economy to adjust to larger capital inflows and outflows. Interest rate deregulation is necessary, because without capital controls, investors will be free to arbitrage interest rate differences between China and the rest of the world. Moreover, with more capital now washing in and out of the economy, it becomes urgent to strengthen the banking system—make it more commercial and subject it to stronger prudential supervision.
Being cautious, the authorities will probably grope forward a step at a time, allowing RMBI to follow in a spontaneous market-based fashion.
But there are other possibilities. Reformists could promote further internationalisation as a way to force greater domestic reform.  This is an approach with higher rewards and risks. If it pays off, China will rapidly begin to harvest benefits from more stable and efficient financial markets and a currency enjoying wide international acceptance. The snag is, with internationalisation outrunning domestic reform, the economy could succumb to financial instability, including capital flight, which then prompts the authorities to put reform on hold and tighten capital controls.
This is happening now. Foreign investors are selling RMB assets out of fear of capital and currency losses, in an illustration of how markets can deal setbacks to the process. And concurrently, the authorities are selectively tightening capital controls to stem capital outflows.
The implications so far seem to be three. First, RMBI has much further to run, particularly in the areas where it lags now. Second, like many processes in their early stages, internationalisation could be marked by rapid ‘S-shaped’ growth for a while, before tapering off once ‘market penetration’ has reached a high level. Certainly that is what the data for the past two years suggest. Third, there could be setbacks along the way, as the current tightening of capital controls and selling of RMB assets illustrate.
The final question to ask is, where will internationalisation culminate? History suggests two broad possibilities—in either a unipolar world in which the RMB dominates all the other freely usable currencies, or in a multipolar world where it is one of the club.
The case for a unipolar ending focuses on the second half of the 20th century when the USD dominated international transactions. This view stresses the importance of ‘network effects’ that encourage traders and investors to use the same currency, in much the same way as the QWERTY keyboard came to dominate other keyboard layouts and English has become the world’s lingua franca. It holds that the RMB will continue to grow in importance, until a tipping point is reached, in which it supplants the USD and other freely usable currencies more or less completely.
The case for a multipolar world focuses on periods where no one currency had hegemony. In the 1920s, the GBP and USD held sway more or less equally. Before the First World War, sterling was the first among equals, but the French franc and German mark each accounted for a quarter to a fifth of international transactions and reserves. This view acknowledges that network effects are important, but claims they are not predominant; other factors such as history, geography and culture also exert influence.
An underlying assumption of both the unipolar and multipolar views is that China will continue to increase its share of world GDP and trade, maintain economic and political stability, and develop deep and liquid financial markets. Commercial scale is important because without it foreigners lack the incentive to adopt the RMB in a big way. Stability matters because foreigners will shun a currency that can’t hold its value or convertibility. And deep liquid financial markets matter because without them foreign investors can’t easily buy and sell RMB assets at stable prices. If the RMB can’t fulfil these three basic requirements, all bets will be off that it will reach the status of a major freely usable currency.
What overall conclusions can we reach? First, there is a good chance that the RMB will climb the currency internationalisation charts a great deal more in coming years provided China remains on a path of convergence with advanced economies. Second, it seems more likely that the RMB will become a major player in a multipolar currency world, rather than a currency hegemon, if only because China will probably follow a slow and gradual path of reform.
Finally, though it is easy to imagine the RMB gaining much wider acceptance among foreigners doing commerce with Chinese, it is harder to picture the RMB being accepted to any significant degree by non-Chinese trading with other non-Chinese. Yet Ghanaian cocoa exporters and their Chilean customers do business on USD terms, as do London money managers with Philippine bondholders. These are the grounds for our suspicion that acceptance of the RMB will lag behind that of the USD for a long time.
‘The Chinese currency is on track to become more important globally, but is unlikely to challenge the dollar any time soon.Eswar Prasad and Lei Ye, Will the Renminbi Rule?’, Finance & Development, March 2012
2. How are Australian companies responding?
RMB invoicing and settlement
As one might suspect, Australia hasn’t been immune to RMBI. After all, China is our No. 1 export market and two-way trading partner. And as trade has expanded, and restrictions on RMB invoicing and settlement have been removed, Australian companies have increasingly moved to adopt the RMB.
Take the international numbers first. As we noted earlier, RMB invoicing and settlement has risen from nothing in 2009, when Beijing first allowed it, to 20% of China’s total goods trade now, and almost 25% of other current account transactions.
Now turn to Sino-Australian trade. A large percentage of Australian companies are reportedly using RMB terms at least to some extent, though the value of bilateral trade done on RMB terms seems to be lower. Take the percentage of Australian companies first. An ANU survey in 2014 found that 37% of respondents had used RMB terms.  Somewhat at odds with this, an HSBC survey in 2015 found that only 13% of Australian companies were using RMB for cross-border transactions.  The ANU survey found that 56% of mining companies had experimented with RMB terms, though ‘many … noted that their invoicing and settlement in RMB only represented 1% of their total trade with China’.  There are also reports suggesting that some mining companies are paying Chinese suppliers for equipment with RMB. 
So RMB usage is already quite significant. But there is also ‘enormous potential for growth in RMB settlement’, according to the Centre for International Finance and Regulation (CIFR).  The potential exists because many Chinese and foreign trading partners could switch to RMB terms for mutual profit. This comes about because the cost of hedging currency risk is higher in China than in Australia. So an Australian importer, say, can offer RMB terms to a Chinese supplier, and in return haggle for a discount. Provided the discount is between the cost of hedging in China and the cost for the Australian buyer, both parties will benefit.
'Australian exporters can typically hedge at lower cost in the offshore CNH market, and sometimes in the onshore CNY market. Exporters have access to the more liquid and better banked CNH market, which can be very difficult for Chinese companies to access.’Guy Morgan, Head of Treasury, Efic
Could the commodities trade be a tipping point?
The place to look for a major switch to RMB terms is the commodities trade. This has traditionally been done on USD terms—and still is. It is the large value of this trade plus its conduct in USD that has held back the overall adoption of RMB terms in Sino-Australian trade.
Yet ‘China Inc’ has now become the largest national buyer of many commodities, is keen to become a world commodity trading hub, has pushed—admittedly with mixed results—for RMB terms with Iran, Nigeria and some CIS states, and has also done so, more successfully, with soft commodity exporters in Thailand, Indonesia and Australia, including woolgrowers. In addition, Brazilian and Australian miners are reportedly weighing up the pros and cons of a switch.
In these circumstances, the CIFR surmises, plausibly, that 'If one large commodity exporter ‘broke ranks’, invoiced in RMB and received a significant price advantage … that outweighed their currency hedging costs, this could potentially have a snowballing effect.’Source: CIFR, Internationalisation of the Renminbi: Pathways, Implications and Opportunities, p. 94
What savings—from switching to RMB terms—are we talking about? According to the CIFR, Chinese companies typically add up to 5% to their quotes in foreign currencies to cover the cost of hedging currency risk.  This chimes with a 2013 HSBC RMB Cross Border Trade Settlement Survey indicating that 53% of Chinese businesses would offer discounts of up to 5% for transactions settled in RMB. Other estimates of the average RMB discounts achievable are: 4.8% by Deutsche Bank and 2-3% by the People’s Bank of China and Standard Chartered. 
What applies to the Australian importer also applies to the exporter, of course. If the exporter can offer their Chinese customer RMB terms, they should be able to charge a premium. And provided that the premium exceeds the cost of hedging, they will be ahead.
So what net advantage are we looking at? We estimate roughly 4% of the contract value—see box.
Illustrative net benefit of switching to RMB terms
We make these assumptions.
1. Australian exporter manages to negotiate 5% price premium for accepting RMB risk.
2. They offer six month credit terms.
3. There is no direct CNH/AUD forward contract. So exporter enters six month CNH/USD and USD/AUD forward contracts to hedge currency risk. Based on market pricing on Feb 26, CNY is expected to depreciate 2% vs USD, while USD is expected to appreciate 1% vs AUD. Netting the two delivers an all-up hedging cost of 1%.
The net benefit of switching to the RMB is price premium minus hedging cost, or 5% - 1% = 4%.
However, the cost of hedging will fluctuate. When depreciation fear is elevated, the cost will be higher. Then again, the exporter might be able to negotiate a larger premium at times like this.
Why have these mutual savings gone unexploited so far? The CIFR suggests a lack of awareness, particularly in China. Thirty nine per cent of Chinese importers and 16% of exporters surveyed were unaware they could deal on RMB terms. Among Australian importers and exporters the awareness was almost universal, though among ‘very small’ companies it fell to 86%. 
Interestingly, 44% of the Chinese firms unaware of RMB invoicing said they would consider using RMB in future. Meanwhile, Australian mining companies are reportedly examining available RMB banking products in preparation for being asked to invoice and settle in RMB.
Are inadequate banking facilities also holding back the adoption of RMB terms? Actually, banks are now much more able to assist their customers manage RMB FX exposures in much the same way they help customers manage other FX exposures.
Apart from the mutual profit to be made, there is another factor that could motivate greater use of RMB terms: the increasing flexibility—and volatility—of the RMB exchange rate. When the RMB was semi-pegged and strong, few Chinese importers saw a problem with invoicing and settling in foreign currencies; the only surprise was likely to be the pleasant one of a windfall from appreciation. But with the RMB now depreciating, or under pressure to depreciate as illustrated by the official reserve drain, they increasingly recognise that they can suffer loss because of foreign currency accounts payable, and in many cases other foreign currency liabilities as well.
Over time, however, if Chinese financial markets integrate with offshore ones, the differential cost of hedging will be arbitraged away. It will then become less important to Chinese and foreign businesses to select RMB terms in order to minimise hedging costs.
We are discussing here a transient opportunity, in other words.
RMB as a funding currency
Putting RMB invoicing and settlement to one side, Australian adoption of the RMB in other areas has been less extensive.
This is a reflection of essentially two things. First, as already noted, Chinese capital controls and backward financial markets hinder Australian portfolio investment into China. Second, the Australian tradition has been to source direct investment from older, Atlantic trading partners plus Japan.
These patterns are changing, however, led by rising Chinese investment into Australia. And it is easy to picture Australian portfolio investment into China rising as capital account liberalisation and financial market development advance. If we assume, reasonably, that the various actors involved make their expanding investments to some degree with the RMB as an invoicing, settlement and funding currency, it also becomes easy to see how RMB use and trading could flourish.
Consider one area of interest to exporters—long-term export credit. We know that bilateral trade on short credit terms has shifted significantly to RMB terms. Has there been a corresponding shift in deals involving long-term credit?
The data here unfortunately are scanty, with the details of most deals kept confidential. Even so, it seems that few deals are conducted with RMB. There are several possible reasons.
On the exporter side, inertia seems to be in play. We have seen transactions that would have been good candidates for RMB loans, earning as they do RMB revenue. Yet the Chinese customer-borrower chose to borrow in USD, thanks to the lower US interest rate, and bear the resultant currency risk.
On the lender side, the major banks don’t appear to offer longer term RMB financing for two reasons.
- Limited borrowing tenor. Banks have difficulties borrowing longer term RMB for on-lending. Capital controls hinder borrowing RMB in China. And the offshore dim sum bond market is shallow and, broadly speaking, lacks tenor greater than three years. However, as with most aspects of RMBI, circumstances are changing. Recent reports suggest dim sum bonds are being sold, and currency swaps arranged, with five, and even 10, year terms.
- Limited risk appetite. Aside from funding problems, it seems likely that banks will have limited appetite for Chinese counterparties for longer tenors. With SME deals, they are also likely to be unenthusiastic about some Australian exporters.
Even so, we could well see in coming years demand arise for longer term RMB export and project finance, and banks seeking to respond.
The rapidly increasing adoption of the RMB in international trade and finance is a real sea-change to which Australian exporters must respond—and are responding. There are strong grounds to believe that adoption of the RMB as an invoicing and settlement currency will run further. There are even grounds to believe that use of the RMB as a funding currency will at some point increase.
- We’d like to thank our colleagues Guy Morgan and Dougal Crawford for helpful comments.
- The Chinese exporter should be prepared to offer a price discount; the Chinese importer to accept a price premium.
- See IMF, Review of the Method of the Valuation of the SDR—Initial Considerations, August 3, 2015
- Neil Irwin, The Choice Facing China As Its Currency Becomes More Global, New York Times, December 1, 2015
- Matt O’Brien, How China is like the U.S. a century ago, Washington Post, December 1, 2015
- Paul Krugman, Small news on the yuan, New York Times, December 1, 2015
- The numbers we cite in this paragraph and the previous one come from IMF, op. cit.
- US Export-Import Bank, Report to the US Congress on Global Export Credit Competition, June 2015, p. 9
- IMF, op. cit. p. 27
- See for instance Eswar Prasad and Lei Ye, ‘Will the Renminbi Rule?’, Finance & Development, March 2012
- A possibility suggested by Barry Eichengreen in Centre for International Finance and Regulation, Internationalisation of the Renminbi: Pathways, Implications and Opportunities, p. 7
- Kathleen Walsh, RMB Trade Invoicing: Benefits, Impediments and Tipping Points, 2014, Table 2, p. 8
- HSBC, Renminbi use in Australia rising, gaining on Asian heavyweights, March 24, 2015
- Walsh, op. cit. p. 7
- Ibid, p. 8
- Ibid, p. 5
- Ibid. p.4
- Ibid. p.4. The Standard Chartered, People’s Bank, Deutsche Bank and HSBC sources are all cited here.
- Ibid. p.7
- Ibid. p.6
- Ibid. p.8