China-Europe Cooperation Promotes RMB Internationalization
By LI GANG
EXPANDING bilateral trade and investments between China and Europe have increased RMB settlements in international trade and financial transactions, accelerating internationalization of the Chinese currency. European countries, with their sound financial infrastructures, complete legal systems, professional supervision, and high market efficiency, have moreover advanced development of the offshore RMB market.
RMB Role as Invoicing
and Settlement Currency
The internationalization of a currency means its wider use in cross-border trade, in the global flow of capital, and in other nations’ foreign exchange reserves, so making it function as an international currency. To become internationalized, the currency must go through three phases: (1) international trade invoicing and settlement currency; (2) financial transaction currency; and (3) international reserve currency.
A currency’s invoicing and settlement function constitutes the foundation of its internationalization. China, which in 2013 replaced the U.S. as the world’s largest trading country, now has trade relations with 127 countries around the world. As China’s foreign trade volume steadily grows, so also does the demand among domestic importers and exporters for cross-border RMB settlement. In 2011 China broadened cross-border RMB settlements to include the whole nation, a move that led to substantial increases in this regard.
Chinese banks handled RMB 1.53 trillion worth of cross-border RMB settlements during the third quarter of 2014, a 36.7 percent increase year-on-year. This included RMB 1.24 trillion in cargo trade and RMB 290 billion in service trade and other current accounts, according to the People’s Bank of China (the central bank) report on implementation of the country’s monetary policy. Of this amount, actual receipts stood at RMB 651.12 billion and actual payments at RMB 882.56 billion, giving a receipt/payment ratio of 1:1.36. The world percentage of cross-border settlements in RMB climbed from 1.9 percent in January 2012 to 8.7 percent in October 2013, according to research and advisory firm Aite Group statistics. U.S. dollar settlements, meanwhile, declined from 85 percent to 81.5 percent.
The brisk growth of RMB settlements between China and Europe is, of course, attributable to the two parties’ close economic and trade cooperation. Eurostat data show that EU-China import and export trade totaled €427.31 billion in 2013, accounting for 12.5 percent of total EU foreign trade. The bloc has been China’s largest trade partner for 10 successive years, and China is its largest trade partner second only to the U.S. From 2000 to 2013, EU exports to China rose from €25.86 billion to €148.21 billion – five-fold that in 2000. China is thus the fastest growing market for EU exports. Over the same period, EU imports from China were also on a largely upward track, hitting €279.1 billion in 2013.
By August 2014, more than one third (33.6 percent) of financial institutions worldwide had used RMB for payments to China’s mainland and Hong Kong, according to monitoring by the Society for Worldwide Interbank Financial Telecommunication (SWIFT). During the two years from August 2012 to August 2014, financial institutions in Europe that had adopted RMB scaled up from 244 to 358. Though the rate of RMB among currencies in total payments on the continent was still below the global average, its 47 percent growth over the two years was nevertheless well above the world average of 35 percent. Europe now accounts for 10 percent of total RMB payments worldwide, making it a main driver of the Chinese currency’s internationalization.
Growing Two-way Investment Enhances RMB Role in Financial Transactions
In recent years the use of RMB as an invoicing and settlement currency in international financial transactions has maintained robust growth, to which the lifting of the ban on foreign direct investment (FDI) in RMB has contributed. Chinese banks handled RMB 469.88 billion worth of FDI in the first half of 2014, including RMB 86.49 billion in outbound investment – 2.94-fold that of the corresponding period in 2013 – and RMB 383.39 billion in inbound investment, up 137 percent year-on-year, according to the People’s Bank of China.
The steep increase of FDI in the Chinese currency stands testament to foreign investors’ optimistic forecast of its appreciation and of the country’s economic growth. Though dwarfed by other major currencies like the U.S. dollar and Euro, FDI in RMB is on a track of strong growth that bodes good prospects for RMB internationalization.
Eurostat data show a substantial rise in EU FDI to China during the 2008-2012 period, its having exceeded €100 billion in 2011 and hit €118.1 billion in 2012, 1.2 times the 2008 level. High-octane growth of Chinese firms’ investments in EU countries has been a new trend in mutual China-Europe investment in past years, according to the 2013 bulletin on China’s outbound FDI, jointly released by the Ministry of Commerce, National Bureau of Statistics, and State Administration of Foreign Exchange. In 2013, the flow of direct Chinese investment to the EU was US $4.524 billion, mostly to the U.K., Luxemburg, Germany, the Netherlands, and France. Although this sum was 26.1 percent less than in 2012, the EU nevertheless remained a leading destination for direct Chinese investment. By the end of 2013 the stock of direct Chinese investment in the region had reached US $40.097 billion, accounting for 6.1 percent of China’s total outbound FDI and 42.8 percent of its direct investment in developed economies.
As the scales of RMB settlement in cross-border trade and FDI in RMB increase, and as the Chinese currency is only partially convertible under capital accounts, the RMB Qualified Foreign Institutional Investors (RQFII) program offers a transitional solution for foreign investors entering China’s capital market. The amount of foreign investors’ financial assets in RMB is also a key indicator of the extent of the currency’s internationalization.
In October 2013 London was granted an initial RQFII quota of RMB 80 billion earmarked for local institutional investors’ investments in China. In June and July 2014, the RQFII scheme expanded to Paris and Frankfurt. The extension of this program to Europe’s major financial hubs facilitates investors’ purchases of stocks and bonds on the Chinese mainland, so boosting the RMB’s function as an invoicing and settlement currency.
Offshore RMB Business Centers
Accelerate Internationalization
RMB settlements of cross-border trade are carried out under conditions where there is neither a fully open RMB capital account nor free convertibility of the currency. As there is no way RMB flowing out of China through foreign trade can unrestrainedly stream back, it is not easy to obtain RMB financing for trade purposes. The solution to problems with RMB investments and financing, therefore, lies in development of offshore RMB markets.
In recent years Europe has been keen on setting up such markets, which is why offshore RMB business is growing at full steam in the region. Amid halting recovery of their economies, certain European countries are jostling for status as offshore RMB business centers in a bid to benefit from the spillover effect of China’s high-octane economic growth. They can thus build on the service capacity and reach of their financial industries, so fueling domestic economic growth and creating more jobs.
The four major European financial hubs – London, Frankfurt, Paris and Luxemburg – are leading this race; other cities such as Brussels and Zurich are about to join in. The SWIFT RMB tracker shows spikes in the value of RMB payments in major European countries. In the 12 months from July 2013 to July 2014, RMB payments from the U.K. showed a growth of 123.6 percent, those from Germany 116 percent, those from Switzerland 57.7 percent, those from France 43.5 percent, and those from Luxemburg 41.9 percent. This gives a world ranking of RMB centers wherein the U.K is second, France is fifth, Germany is seventh, and Luxemburg is ninth.
The U.K. was the first in Europe to start offshore RMB business. Since the City of London officially launched its RMB business center in 2012, the city has made steady headway in this regard. In the second half of 2014 the People’s Bank of China signed agreements with central banks in the U.K., Germany, France, and Luxemburg on establishing RMB clearance banks in these four European countries. In June 2014 the China Foreign Exchange Trade System (CFETS), with a warrant from the People’s Bank of China, announced the start of direct trading of the yuan against the British pound on the interbank foreign exchange market. This cuts exchange costs and boosts use of the two currencies in bilateral trade and investment between China and the U.K., so enhancing their financial cooperation and economic ties.
Currency swaps play a critical role in shoring up bilateral trade, offering protection from financial risks, and reducing financing costs. Since 2008 the People’s Bank of China has sealed currency swap deals with 25 countries/regions worldwide, including six in Europe – Iceland, Ukraine, the U.K., Hungary, Switzerland, and Russia – in addition to that with the European Central Bank. This has boosted the RMB’s global influence.
In October 2014 the British Treasury issued RMB 3 billion in RMB-denominated sovereign bonds. The RMB thus became one of Britain’s foreign exchange reserve currencies. The move consolidated the U.K.’s position as leading offshore RMB market in the West, providing liquidity in the offshore RMB market. It was another stride towards internationalization of the Chinese currency.
But the road to RMB internationalization is long and hard. SWIFT figures rank the RMB as the world’s seventh most used payment currency, but it accounts for a mere 1.59 percent of the value of global payments, compared with the 43.5 percent on the part of the U.S. dollar and the Euro’s 29.38 percent. Similarly, about 60 percent of total identified official foreign exchange holdings are in U.S. dollars. The RMB does not yet figure in this composition, according to International Monetary Fund (IMF) data on the currency composition of international foreign exchange reserves.
Increments in the real economy and bilateral trade and investment constitute the driving force behind the development of RMB business. Despite strong growth, two-way investments between China and Europe remain an insignificant share of each party’s total foreign investment. They therefore constitute a weak link in the development of offshore RMB markets. The narrow range of RMB financial products, absence of an international RMB payment system, and an exchange rate and interest rate not fully based on the market are other negative factors inhibiting internationalization of the Chinese currency.
But opening capital accounts and internationalizing the RMB is an irreversible trend. Given the merits of main European financial centers, including high openness, big capacity, and good infrastructures, and the prospect of growing trade and investments between China and Europe, there are good prospects for offshore RMB markets on the continent. The upgrading of China’s industrial and trade structures and deepening of reforms to its financial system will also contribute to the steady progress of RMB internationalization.
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LI GANG, Ph.D. in economics, is an assistant research fellow at the Institute of European Studies of the Chinese Academy of Social Sciences.
