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The renminbi has come a long way in the past two decades. As recently as 1994, foreign visitors to China were still consigned to using special “foreign exchange certificates” rather than local currency. Only select stores and restaurants were permitted to accept them.
Progress has been even swifter since July 2005, when the Chinese government announced it was removing the currency’s tight peg to the US dollar.
Since then the renminbi has appreciated more than 30 per cent against the dollar and the central bank has scaled back its intervention in the foreign exchange market. Rmb trade settlement is rising, with 20 per cent of China’s merchandise trade settled in its own currency in 2014.
Yet the recent boom-bust cycle in the Chinese stock market has renewed doubts among foreign investors about the wisdom of allocating large sections of their portfolios to renminbi assets.
While most investors can accept market volatility, the government’s heavy-handed response, which has included a ban on sales of equities by big stockholders and trading suspensions affecting thousands of listed companies, has reminded investors that investing in China comes with political as well as financial risks. The prospect of being trapped in an unwanted investment due to ad hoc administrative intervention is not an enticing one.
Yet the long-term trend is still towards increased foreign acceptance of the renminbi for both trade and investment.
Trade settlement has also facilitated the accumulation of renminbi outside China. Offshore renminbi centres, led by Hong Kong, have sprung up in financial areas such as Singapore, London and Frankfurt, allowing governments and a broad range of companies to issue renminbi bonds.
Capital controls restricting portfolio investment into and out of China have also been on a loosening trend, notably through the launch of the Shanghai-Hong Kong Stock Connect last November. Even as the International Monetary Fund considers whether to endorse the renminbi as an official reserve currency, more than 60 central banks have already invested in renminbi assets, according to Standard Chartered.
In July, the central bank widened access to its vast domestic bond market for foreign central banks, sovereign wealth funds and multilateral financial institutions such as the World Bank. These institutions no longer require licences to invest in Chinese interbank bonds, as well as money market instruments such as repurchase agreements.
Outbound foreign direct investment is now subject to greatly reduced regulation, as China encourages domestic companies to “go out”. Foreign mergers, acquisitions and greenfield investments by Chinese companies below a certain threshold, typically $100m, no longer require approval from the foreign exchange regulator.
For inbound FDI, many sectors of the Chinese economy remain restricted to foreigners, or off limits entirely, but the approval process is easier than before for sectors where investment is allowed.
In addition, China is using the Shanghai free-trade zone to experiment with a “negative list” approach to foreign investment. Rather than stipulating specific areas as “encouraged”, “restricted”, or “forbidden” for foreigners, the negative list will specify those that are closed. Any sectors not on the list are assumed to be unrestricted.
Despite such progress, by many measures the Rmb remains a middling player in the global currency markets. In terms of global foreign-exchange turnover, it still trails the Mexican peso and Canadian dollar.
Interest and exchange rates, though freer than before, remain subject to government control. China has pledged to complete both interest-rate liberalisation and “basic” capital account convertibility by the end of 2015. But it is clear that Beijing’s definition of these terms still leaves plenty of room for government interference in the market.
The market also lacks derivatives that would allow investors to hedge risk or make bearish bets. The interest-rate swaps market is relatively liquid, but more sophisticated tools such as cross-currency swaps remain thinly traded. Equity derivatives are still in their infancy, with futures and options only available on broad indexes, not individual shares.
Capital controls still severely restrict investor access to China’s onshore bond market. The increased access that central banks now enjoy does not extend to private-sector asset managers, who can only obtain access to the onshore market through the Qualified Foreign Institutional Investor Programme (QFII) or its renminbi-denominated cousin, RQFII. Even once a QFII licence is obtained, each asset manager is subject to a separate quota from the foreign exchange regulator. And for individuals, the domestic bond market remains completely off limits.
For the stock market, access is easier. Foreign investors buying into the Chinese stock market using the Stock Connect do not need a licence, but many stocks remain off limits and quotas limit daily flows and overall investments. Moreover, the Chinese stock market’s recent bull run, followed by its sudden downward correction, has made many foreign investors wary of participating, even where regulations allow it.
Global index provider MSCI recently declined to add Chinese onshore stocks, known as A shares, to its benchmark emerging market indexes. Though they cited technical concerns about the ownership status of shares bought through the stock connect programme, many observers privately believe that MSCI’s decision was also motivated by investor concerns about the stock market’s reputation as a casino.
Number of central banks that have invested in renminbi assets, according to Standard Chartered
The addition of A shares to the indices would have triggered billions in fund inflows via funds that passively track them. Even before the share crash that began in late June, such a prospect made many of MSCI’s fund manager clients nervous.
As China proceeds cautiously but inexorably with financial reform, the importance of the renminbi is bound to increase. But whether the currency will ever take on an importance commensurate with China’s status as the world’s largest economy (in purchasing power parity terms) is still an open question.