The Internationalisation of the Renminbi

China’s Belt and Road Initiative (BRI) has given new impetus to the evolution of Asian capital markets.

An interview with Candy Ho, Global Head of Renminbi Business Developments and Head of Corporate Treasury Solutions, Greater China at HSBC

These developments, as well as changes to regional currency baskets, are likely to accelerate further the internationalisation of the renminbi, according to Candy Ho, Global Head of Renminbi Business Developments and Head of Corporate Treasury Solutions, Greater China at HSBC.

“There has been a lot of discussion as to how the renminbi is behaving, which primarily relates to its exchange rate against the US dollar,” she says, noting that the US remains one of China’s largest trading partners. “But China has also been trading a lot with the rest of world, with Europe and Asia, and with the introduction of the BRI by the Chinese president, Xi Jinping, back in 2015, there are more and more cross-border activities between China and the BRI countries.”

The development of BRI projects is expected to lead to increased use of the renminbi and, ultimately, to its normalisation as a trading currency, Ms Ho says. At the same time, as the BRI impacts capital markets in the Association of South-East Asian Nations (ASEAN) region, foreign investors will need to ensure that they have sufficient measures in place to protect against potential currency exposure from loans or investments in more volatile currencies in BRI countries.

A new role for the renminbi

Against a backdrop of currency volatility, last year China introduced changes to its key renminbi exchange index, the China Foreign Exchange Trade System (CFETS), adding 11 new currencies to the existing 13 in the CFETS basket. The new currencies included the Korean won, the South African rand and the Mexican peso.

Many of the newer currencies in the basket are those of emerging markets, some of which lie along the BRI routes. Given that many of these currencies are likely to exhibit higher levels of volatility than their developed-market counterparts, benchmarking the renminbi to this basket is likely to lead to further volatility for the Chinese currency as well, Ms Ho says.

“At the same time,” she adds, “given that the BRI will potentially be increasing the trading volume, increasing cross-border trading activity between China and the BRI countries, the weighting of those BRI currencies may eventually increase further as the countries along the Belt and Road become trading partners of China.”

Nevertheless, Ms Ho says that she expects the greater transparency and more market-driven exchange rate for the renminbi to allow it to behave “more like a normal currency, where its valuations are linked up with its trading partners,” despite the increased fluctuation in the exchange rate.

“It is definitely a more healthy volatility, more two-way compared with the past two years, where you either saw a one-way appreciation or one-way depreciation,” she adds. “It’s definitely one of the steps toward renminbi internationalisation.”

Upside for financial markets

As US equity markets continue to exhibit volatility, some investors are parking more funds in the renminbi, allowing it to function “a bit more like a reserve currency,” Ms Ho observes.

Greater demand for access as regional capital markets open up will help to drive more demand for the underlying currency, she says, adding that “with more of these kinds of cross-border hedging trades and investments going on between China and the rest of the world, we will see more volatility and normal market behaviour”.

Increased currency volatility as the BRI evolves is also likely to lead to further margin compression, as growth in the number of participants leads to tighter bid/offer corridors. This in turn is likely to be beneficial to clients looking to manage potential risk and volatility due to currency exposure.

The need for better risk management

As cross-border trade, investment and financing activity accelerates as part of the BRI, companies will need to put their processes for managing fluctuating currencies under greater scrutiny. “Corporates should consider hedging solutions according to their risk appetite,” Ms Ho says.

To illustrate the conundrums that investors might face, she uses the example of equipment suppliers and manufacturers that are awarded a contract in Poland for a BRI project.

Although project earnings will be denominated in Polish zloty, the majority of procurement contracts are more likely to be denominated in euros, and company profitability will need to take into account the potential depreciation of the zloty.

“So, when investors participate in a lot more of these cross-border foreign projects, they will also need to consider the underlying currency exposure – if you are buying or have a procurement contract or are investing in the local currency, how does it translate back to your home currency?” she says.

In addition, with BRI projects typically involving investment in infrastructure, such as railways or long-term oil and gas development, initial stages will generally require significant project financing to fund the various phases of development.

“There again, a corporate will need to undertake technical consideration of what the financial costs are, what kind of interest-rate volatility and currency exposure there is and in what currency that loan should be denominated,” Ms Ho adds.

Many Chinese companies have been investing heavily in ASEAN countries as well as in Eastern Europe, requiring them to consider carefully whether to borrow in renminbi or in foreign currency; in the latter case, the question is often whether to borrow in US dollars or euros, which are typically the most liquid currencies, or in the currencies of the countries where the project is based – for example, the Malaysian ringgit or the Polish zloty. Being aware of the interest-rate cycle is key to making these kinds of decisions.

Decisions about funding for infrastructure development should also take into account the maturity of the financial market in which the BRI project is taking place.

“US dollar markets are very well established and mature in infrastructure financing,” Ms Ho points out, noting that many loans for infrastructure and project financing have terms of up to 30 years. By contrast, domestic capital markets in Malaysia or the Middle East may not have the same depth, and this might impact the market course for financing.

“One of the key financing alternatives for projects along the Belt and Road would be using the capital markets, so corporates could issue long-date bonds in order to enable long-term financing,” she adds. “So even though a market loan would not typically be extended to ten and fifteen years in China, they could potentially issue long-term onshore domestic bonds; we have seen overseas corporates issuing 'Panda' bonds to raise funds to finance their Belt and Road projects.”

In 2017 Malaysia’s Malayan Banking (Maybank) issued a renminbi-denominated bond in China, the proceeds of which will be used to finance BRI projects in Malaysia. Malaysia also has a burgeoning market for sukuk (Islamic bonds).

Meanwhile, the existence of a variety of types of financing for BRI projects is also drawing in investors that might not normally put money into in emerging markets, Ms Ho says. The fact that many BRI initiatives have some kind of government backing – in the form either of initial infrastructure financing or of multilateral funding from institutions such as the Asian Infrastructure Investment Bank and the China Development Bank – is making many Western investors more comfortable, she adds.

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