Three years ago, China's policy of hampering the movement of its currency across national borders and in currency markets shielded its banks and investors from the worldwide financial crisis. But as its rapid-growth, globalized economy threatens to burst at the seams, China's isolationist policy for the renminbi (or yuan) now threatens its future.
So China has made a big first step, allowing banks and companies to settle payments with cross-border trading partners in renminbi (RMB). Simply, a U.S. multinational can now pay a Chinese supplier in RMB, and a qualified Chinese buyer can pay a U.S. supplier in RMB.
In reality, there are now two forms of RMB that trade at slightly different exchange rates. Foreign companies can accumulate the more freely tradable version of the Chinese currency — informally called offshore RMB — in bank accounts newly available in Hong Kong and elsewhere. Using those accounts, they can pay Chinese suppliers (and trading partners in some other Asian countries) and accept payments from their Chinese customers. And foreign-exchange conversion of RMB — the "offshore" variety — is now permitted, with limits.
All of this is good news for U.S. companies, some of which have had to settle trades with Chinese suppliers in U.S. dollars, while others have struggled to benefit from the excess RMB they have stockpiled on the mainland.
On the other side of the transactions, Chinese suppliers are welcoming the ability to deal in RMB. "By settling in RMB, multinational corporations can improve the terms of trade," says Philippe Jaccard, head of global liquidity and investments in Asia-Pacific for Citi. "Chinese suppliers and distributors will no longer need to deal with the foreign-exchange risk."
And for U.S. multinationals selling in China, if their customers have the necessary clearance to get their onshore RMB payments converted to offshore RMB, U.S. treasurers will have a lot more flexibility with the cash they generate.
Of course, companies need to carefully weigh the decision to deal in RMB. "Treasurers need to keep in mind that there is still higher risk of convertibility and transferability than with the U.S. dollar," says Jaccard.
Cross-border trade settlement in RMB reached $78 billion in 2010 — about the size of the U.S. wedding industry — and has already surpassed that in 2011, according to the People's Bank of China. In the first quarter, say analysts, about 7% of China's imports and exports were settled in RMB, versus 0.5% a year ago. That could climb to 40% — or $2 trillion — in three to five years, say some bank economists.
The tools to deal in renminbi are developing commensurately. Deutsche Bank, for example, is opening RMB accounts in Hong Kong at a rate of 20 per week. While some of that represents investors trying to cash in on the currency's appreciation versus the U.S. dollar, others are using the accounts for trade. Payments company Travelex introduced business transfers in renminbi in early July. The service uses Travelex's proprietary clearing network instead of banks' systems.
The benefits of paying Chinese suppliers in RMB are hard to ignore, says Gareth Heald, Travelex's finance director for North America. "When invoices are in U.S. dollars, the Chinese supplier factors RMB appreciation into the price, so they lack transparency," Heald says. By paying in RMB, a large corporation can control its exposure to RMB-to-U.S.-dollar appreciation. At the same time, the receiving company gets the payment faster, which could allow it to release the goods sooner, Heald adds.
So far, it's multinationals with lots of experience in China that are adopting RMB payments, says Feng Xue, chair of the Asia/China practice at Katten Muchin Rosenman; other businesses remain cautious.
Multinational buyers need to make sure that the Chinese trading partner is signed up with the pilot program, of course. About 70,000 Chinese firms have already done so. "You can't just remit to any beneficiary," Heald cautions.
Into the Pool
For multinationals garnering profits in mainland China (think McDonald's, Yum Brands, and General Electric), the liberalization of the renminbi provides possible solutions to a long-standing problem: what to do with the local currency that they generate. Due to government regulations, "it's been a real headache to get money out of China," says Xue, especially capital that doesn't come directly from aftertax profit.
Yet in truth, few U.S. businesses have the motivation to convert their RMB profit into U.S. dollars and send it back to headquarters. The U.S. tax code discourages profit repatriation, for one, and "the markets are making it good to hold RMB," says Lewis Sun, head of sales for global payments and cash management at HSBC Bank (China) Co. Ltd. According to some analysts, the highly controlled RMB is still as much as 40% undervalued relative to the U.S. dollar. "At this moment, appreciation is a very tangible benefit," Sun says.
But the offshore renminbi opens the door to other choices. Under the new rules, for example, a company manufacturing within China that gets paid in offshore RMB could pay for goods coming from other Asian countries with that cash, says Citi's Jaccard. A multinational company with a sophisticated treasury operation could also use a base of RMB deposits to set up a multicurrency notional pooling, says Jaccard. (A notional pooling is a treasury tool that combines the balances of cross-border accounts to offset interest as well as assets and liabilities.)
"In effect, [the pooling] can recycle excess RMB into a U.S.-dollar pool to fund the rest of the company's operations without the balance-sheet cost," says Jaccard. The only restriction: the offshore RMB has to have accumulated from trade transactions. With some banks, offshore RMB deposits could also be used as collateral to borrow money in other currencies or to get cheaper financing from the deposit bank.
Of course, multinationals striving to expand their exposure to China and keep up with a heated economy will use RMB earnings to fund growth there. "General Motors has set an ambitious sales target of 5 million cars in China by the year 2015, demanding huge capital spending," points out Clark Li, a partner in global investment research at asset-management firm Balentine. Using tax rebates and tax exemptions, moreover, the Chinese government strongly encourages multinationals to deploy their RMB capital inside China.
A Continuing Divide
Multinationals were reluctant to hold RMB before the new rules took effect, and despite the creation of a more freely tradable offshore version, many firms may still hesitate. For one thing, RMB deposits earn a very low yield because there are a "huge" amount of deposits offshore (mainly in Hong Kong) and still few assets, Jaccard says. He puts the current tally at about 450 billion RMB in deposits and 65 billion RMB in assets. The bonds are mostly short-term and scarce, and share issuance "hasn't been hugely successful yet," he says.
Second, once RMB is offshore, a firm needs government approval to bring it back onshore for investment. "The regulator is fairly restrictive," says Jaccard, "because its intent is to create an international currency, not to see the RMB coming back and fueling an economy that's already on steroids."
There are no published, explicit rules on how RMB can be brought back into mainland China, but "if you want to speculate in real estate, the likely response will be no," says Jaccard. "If you want to build a factory in central Sichuan that will employ 10,000 workers, the answer is more likely to be yes."
Jaccard expects RMB offshore deposits to grow rapidly, while assets will grow more slowly. Eventually, there could be more of an equilibrium if market sentiment shifts and there is no longer the expectation of RMB appreciation, creating less of an incentive to hold RMB and more of an incentive to borrow in RMB; or if China's capital account opens entirely.
In the meantime, by letting RMB be used as an invoicing currency, China can combat large flows of U.S. dollars into mainland China. "The government is trying to tighten liquidity in the market to cope with inflation — that's a key target this year," says HSBC's Sun.
Longer-term, the RMB could be fully convertible by 2015, say experts, but right now, Li says, the Chinese government is cautious. "China will definitely give up its strict RMB control policy — it has definitely made a decision in that direction," he believes. Treasurers, stay tuned.
Vincent Ryan is senior editor for capital markets at CFO.