26 July 2016 • Source: Ee Chuan Ng, China Head of Sales, Bloomberg L.P.
As China’s financial markets continue on their march to further opening, the renminbi entered a new era of relative volatility in the last year after a long period as one of the most stable and predictable currencies in the world. While much of the focus has been on the short term movements of the renminbi and what they mean, we see a parallel trend in market participants shaping a long view as the role of the yuan in global trade grows and its potential as an international investment currency is realised.
Our analysis points to the gradual emergence of a renminbi long view anchored by three factors – China’s exchange rate policy developments, the yuan as an investment currency and global investor interest in the Renminbi for the long-term.
Short-term currency volatility & long-term exchange rate policy developments
The triggers for increased volatility in the yuan over the last year can be largely attributed to turbulence in the global economy, combined with moves by China’s central bank to improve the market mechanism of the yuan exchange rate.
On the sidelines of the lnternational Monetary Fund (IMF) and World Bank meetings in mid-April, Governor of the People’s Bank of China commented: “China will continue to pursue market-based exchange rate reform, and maintain the renminbi exchange rate basically stable at a reasonable and equilibrium level.” He said the renminbi has remained “basically stable” against a basket of currencies and there is no basis for persistent renminbi depreciation. Bloomberg Intelligence Economist Tom Orlik says that the challenge in predicting movements in the yuan reflects the difficulty of understanding the dynamics of a currency in a stop-start transition from government to market control, and from one-sided appreciation expectations to a more balanced market view. Back in December 2015, he presented a matrix, which has played out over the last few months, where China experienced the Goldilocks scenario; market panic in Q1 when the central bank reasserted its control bringing, the yuan back to half way and the crawling peg today where stability is restored.
Greater openness and communication on exchange rate policy by China is helping to create a more transparent and certain view of policy going forward, drawing praise from Christine Lagarde, Managing Director of the IMF, stating: “I think when it comes, in particular, to the exchange rate regime, it does clarify the situation for the better, because nobody likes uncertainties, markets in particular.”
Long-term potential of the renminbi as an investment currency
The inclusion by the IMF of the yuan in the SDR basket acts as a spur for its enormous potential as an investment currency. The yuan is now traded in Hong Kong, Taipei, Singapore, Frankfurt and London – driven by the fact that China is now the world’s biggest exporter eclipsing the US, Germany and Japan. In 2013, only Hong Kong had Renminbi Qualified Foreign Institutional Investor (RQFII) status. Now there are 16 markets, broadening access to and use of the quota.
At the China Development Forum this year, Bloomberg Chairman Peter Grauer noted that an increased international role for the yuan as an investment currency could act as an accelerator for China’s reform processes, building on the significant progress already made in capital market reform and opening.
“A challenge for all of us – policy makers and market participants – in China and around the world is to develop the market infrastructure required to underpin the yuan’s new international role,” he said.
Michael Bloomberg is chairing the Working Group on US renminbi Trading and Clearing, a group including 22 members from international financial institutions and Chinese banks, focused on identifying, evaluating and recommending opportunities to develop and expand renminbi trading, clearing and settlement in the US. The working group believes that increased access, reduced complexity and provision of American businesses with new tools to facilitate trade and financial transactions with China, will ultimately benefit mid-tier businesses and financial institutions, assist in job creation and open new opportunities for growth.
Clearly, this is a long-term effort, but there is plenty of room for the renminbi to grow as an international investment currency. The continued internationalisation of the yuan, its growing role as a trade settlement currency and the opening of China’s onshore capital market are key drivers to the renminbi on course to one day becoming a global investment currency.
Investor interest in renminbi is long-term
Market players we speak to in global financial centers are starting to appreciate the renminbi long view and are adjusting their approaches to analysis and decision making on the renminbi. At an event we hosted in London for over 400 offshore China participants, changes to the renminbi fixing mechanism and interest rate liberalisation were seen as the most interesting moves among China’s recent liberalisation initiatives.
Almost three quarters of participants indicated that more connectivity to China’s trading platforms and systems was important to them, while 60% rated internationalisation of the renminbi as being of significant interest to them. In our view, this is an indicator that market participants are moving to a longer term and more in-depth assessment of the potential and role of the renminbi going forward. This interest will only increase as global index providers review the inclusion of China into their benchmarks indices. As these proceed, it could open the door to one of the most significant transitions in global asset allocation seen in recent years.
Deeper and more liquid international renminbi markets should have a smoothing effect on renminbi’s volatility. As that happens over the longer term, market transparency and access to equally deep data and analysis will be key to creating well-informed international renminbi markets.