Yuan will open up, cutting costs for GCC firms
KCIC ASIA ECONOMIC REPORT
KUWAIT: Some currencies have a disproportionate importance in the world compared to the economic weight of the country that issues the currency. That is the case of the US dollar (USD). The United States is the largest economy in the world, representing around 22 percent of global GDP. Its share of global trade is much lower, around 10.7 percent of total world’s imports and exports. But the USD is used in 36 percent of global payments of any kind. The opposite is the case of China.
The second largest economy of the world accounts for 11.2 percent of global GDP but its currency ranks number 11, used only on 0.87 percent of global payments. The relatively low use of the renminbi (RMB) is even more notable if we take into account that China is the world’s leading trading nation, slightly ahead of the US. Only two years ago it ranked 17th, with 0.6 percent of global payments.
The comparison of trade shares and currency utilization between the United States and China shows the countries’ different uses of their currencies. The dollar is a fully international currency, widely used to settle payments. It is also fully convertible, because there are virtually no limits to the amount of currency inflows and outflows in the country. Most importantly, it is a reserve currency held by central banks to store value, granting the US access to a virtually infinite pool of cheap credit.
The Chinese renminbi has none of these characteristics simply because its authorities did not want it to have them. The very successful Chinese export led growth model was based on controls of the exchange rate, stock markets, capital movements and interest rates. A heavily manipulated exchange rate allowed the currency to remain stable and competitive in spite of massive demand for Chinese goods. A restricted stock market and capital controls ensured that savings from corporate and individuals ended up in government banks in spite of the low interest rates offered. Banks would then provide state-owned companies with cheap credit to invest.
But this system no longer works. Chinese citizens, desperate to get some return on their savings, turned to real estate, provoking a serious bubble that could paralyze the country if it turns sour. Local govern- ments, which depend heavily on revenues from land sales, encouraged construction. Those that could not afford a house, put their monies in the shadow banking system, unsafe but more profitable. Meanwhile, the private sector, the only real employment generator, chokes without access to credit as government firms take all the funding. If this vicious circle is not broken, the stability of the country and the Communist Party power will be at stake. The Chinese authorities have realized that liberalization is necessary to move forward, and the internationalization of the currency is a priority.
A gradual liberalization of the Chinese currency would have a significant impact on the global economy. The most significant one would be the reduction of both, foreign exchange risk and costs. Take the case of the GCC. In 2012, the region exported $79 billion worth of goods to China. China had to buy that amount of USD to pay for those exports, mostly energy. These USD were in turn used to buy Chinese RMB to pay the $52 billion of imports that the GCC bought from China. In total $131 billion were exchanged from RMB to USD, producing hefty fees for banks. An international RMB could allow all buyers and sellers to hold RMB accounts in any of the many clearing centers, and perform most of the operations in RMB, avoiding the need to buy USD.
Financing costs would be lower, even more in a context like the current one in which many financial and non-financial firms struggle to get liquidity in USD to perform their operations. However the internationalization of the renminbi will not imply a structural change in the world monetary system in the next decade. Without a doubt, the Chinese currency will gain relevance as an international currency, but the Chinese authorities will not accept a fully liberalized renminbi. The likeliest scenario in a decade is one in which the RMB reaches a status similar to that of the Japanese yen today. The rising volumes of RMB held by firms would multiply, forcing companies to manage their treasury more actively to maximize returns: just leaving it in the till, waiting for the currency to appreciate is not good enough. Substantial opportunities would be created for banks and asset managers in the GCC designing products to hedge against the renminbi risk and generate returns.-Francisco Quintana is Senior Economist from KCIC.