The renminbi’s inclusion in the SDR adds impetus to its internationalisation

Bank of China (Hong Kong) highlights the importance of opening up the onshore renminbi (RMB) foreign exchange market and improving the development of offshore RMB FX markets.

In October 2016, the International Monetary Fund (IMF) added RMB to the basket of currencies that make up the special drawing rights (SDR). The value of the SDR is defined using a basket of major currencies, which are selected based on their importance in the world’s financial and trading systems. With a weight of 10.9%, RMB ranked third after the US dollar and the euro. 

This marked an important milestone in the integration of the Chinese economy into the global financial system. Since then, RMB has achieved major progress towards becoming an international currency in terms of payment, trade finance, foreign exchange, investment and reserve asset as follows: 

1. RMB as a payment currency 
According to payment services firm Swift, the value of RMB payments has maintained rapid growth for four consecutive years, with a total of  $69 trillion in 2020. In June 2021, RMB was the fifth most active currency for domestic and international payments by value, with a share of 2.5%, behind the US dollar, euro, sterling and Japanese yen.

2. RMB FX trading volume
According to a survey from the Bank for International Settlements, the average daily turnover of RMB FX transactions reached $284.2 billion in April 2019, accounting for 4.3% of the global total, an increase of more than 40% from three years ago. RMB then became the fastest-growing currency in terms of FX transactions among the major international currencies, with Hong Kong, London and Singapore its major overseas FX trading centres.

3. RMB as a reserve currency
According to the IMF, in the fourth quarter of 2020, reserves held in RMB by central banks increased to $267.5 billion – twice the volume as before 2016, when the currency was officially included in the SDR currency basket. RMB assets’ share of official foreign reserves held by central banks rose to 2.45% as of Q1 2021. 

4. RMB as an investment currency
Foreign institutions and individuals have increased their investments in China’s onshore capital market through various access channels, such as the Qualified Foreign Institutional Investor and RMB Qualified Foreign Institutional Investor programmes, Stock Connect, Bond Connect and China Interbank Bond Market. By the end of 2020, foreign institutions snapped up CNY3.25 trillion worth of bonds, an increase of CNY1.07 trillion, or 49%, year-on-year.

In addition, the offshore RMB markets have grown rapidly. Today, RMB clearing arrangements cover 25 countries and regions, connected with the domestic clearing system through the Cross-Border Interbank Payment System. Hong Kong, London, Singapore and New York have developed into key offshore RMB centres jointly covering RMB business worldwide. In recent years, major RMB business indicators in those financial centres have continued to rebound, reflecting the steady development of RMB internationalisation.

Wider recognition

At the end of 2020, central banks held $267.5 billion worth of RMB within their FX reserve portfolios, nearly triple what was held before 2016. The inclusion of RMB in the SDR basket has meant that RMB has become one of the currencies from which IMF member countries can choose when lending. More than 70 central banks are currently holding RMB within their foreign reserve portfolios. For example, RMB accounted for 12.8% of the Bank of Russia’s FX reserves. 

Central banks tend to consider two main factors when it comes to their investment portfolios: safeguarding capital in terms of value appreciation, and liquidity and exchange rate risk. 

China has been the first major economy to recover from the Covid-19 pandemic in terms of its economic fundamentals. With regard to liquidity and exchange rate risk, RMB could arguably be seen as a safe-haven asset. Furthermore, the opening of China’s capital market to foreign sovereign investors has further boosted confidence in RMB; investors can now conduct transaction settlement, capital transfer and FX, with few restrictions. This should further encourage investors in RMB assets to hedge against risks arising from US dollar assets. 

Evidently, the US dollar continued to depreciate in Q4 2020, which accelerated the process of FX reserve diversification by global institutions to reduce the risks of over-concentration in US dollar assets. RMB government bonds, which have lower FX volatility compared with other countries, provide a relatively safe and high-return option. 

To safeguard capital in the face of value appreciation, the key to determining the attractiveness of RMB assets lies in China’s economic conditions. China’s share of global GDP grew to 17.5% in 2020, and its share of global trade value of goods also grew to 12% in 2019. Following the Covid-19 pandemic, China has managed to restart its industrial supply chain, emphasising the importance of global supply chains. 

China is currently the only country that continues to use conventional monetary policy tools while maintaining a positive interest rate differential against the US dollar. In Q4 2020, the average yield of China’s 10-year government bonds was 3.27%. In comparison, the yields of the US and Germany’s government bonds were only 1.36% and -0.31% during the same period, respectively. This highlights the investment value of RMB for the central banks. 

In 2020, foreign central banks increased their Chinese bond holdings by $47.1 billion – greater than the average US dollar bond increase of $41.1 billion in the past five years. In total, foreign central bank holdings of Chinese bonds reached $263.7 billion, accounting for approximately 51% of all foreign institutions’ holdings. There are a growing number of central banks and sovereign wealth funds that have achieved asset appreciation through investing in Chinese government bonds.

Potential for wider international use

The share of RMB settlement in terms of cross-border trade and investment is still low, accounting for only 15% of total goods trade with China in 2020. The US dollar is still the major currency for China’s foreign-related receipts and payments. Foreign holdings of onshore RMB bonds accounted for 4.2% of the total in 2020, much lower than the 29% share of foreign holdings in the US Treasury bond market. 

This should not be taken lightly, and should be addressed through continuous opening up and improvement of China’s financial market. To further advance the internationalisation of RMB, the following relationships must be carefully managed:

1. Opening-up and stability
The internationalisation of RMB and capital account liberalisation are the twin drivers of the opening up of China’s financial markets, which complement and support each other. We are seeing rapid growth of onshore capital inflows but, as China deepens its capital account liberalisation, increasingly complex cross-border risk management must be maintained. Currently, overseas investors’ booming demand for RMB assets is driven by the attractive interest margin and the China-US interest rate spread. 

These factors are all cyclical. However, under normal conditions, capital flows both ways. To deal with financial stability challenges brought by capital account liberalisation, Chinese authorities need to strengthen the prudential regulatory frameworks of cross-border capital flows, while maintaining RMB’s flexibility. Timing and pace are also important.

2. Onshore and offshore markets
The acceleration of opening up domestic markets has made it convenient for overseas investors to settle transactions onshore. The continuing trend of RMB inflows investing in domestic markets, to a certain extent, would tighten offshore RMB liquidity. If offshore RMB liquidity is not improved through widening RMB outflow channels, or increasing the overseas use of RMB, offshore RMB business will be inevitably affected in the long term. 

With the main RMB market located onshore, from an overseas investors’ perspective who are familiar with the offshore market practices, the offshore RMB markets are an important gateway or buffer zones for them to deal with the opportunities and challenges of entering into China’s onshore capital markets. As a result, authorities need to make sure they balance the relationship between onshore and offshore RMB markets so that offshore RMB centres such as Hong Kong can continue to play an active role in promoting the internationalisation of RMB. 

3. Local currency and foreign currency
Once overseas investors have RMB asset holdings, they need to implement exchange rate risk management tools to hedge their foreign currency exposure. With the increase of RMB asset holdings by foreign institutions, there is an urgent demand for an open RMB FX market to carry out the relevant transactions for liquidity management and hedging purpose. 

This highlights the importance of opening up the onshore RMB FX market and improving the development of the offshore RMB FX markets. To advance the internationalisation of RMB, we need to facilitate overseas institutions entering into domestic FX markets, and further promote trading activities.

 

This feature forms part of the Central Banking focus report, The renminbi’s rise to prominence

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