Internationalising the Renminbi

Despite denials that China will be proposing a new currency regime at this weekend's G8 meeting, recent actions suggest that China is preparing to "internationalise" the Renminbi. Essentially, this will allow the currently controlled currency, to be more freely available, for trade purposes (initially). This is a major development and I expect more media coverage soon. In the meantime, below are some of the main points, extracted from a HSBC publication.

China has previously complained of their dissatisfaction of how the US is managing its economy and the resultant impact of a weakening USD. To counter their over-reliant on the USD, China has embarked on an ambitious scheme to raise the Renminbi's (CNY) role in International trade and finance. This is a multi-year, gradual process but it will be a structural shift - a paradigm shift in world economics.

In the initial phase, the plan will focus on expanding CNY role in settling cross-border trade. Already the Authorities, have introduced measures such as tax break, trade finance and currency swaps arrangement, to encourage the switch from USD to CNY settlement. Combined with the USD uncertainty, as much as USD2 trillion worth of trade flows, or 40-50% of China's total trade could be settled in CNY by 2012.

In the longer term, this internationalising of the CNY will have other key implications. Firstly, by pricing in CNY, exporters will reduce their cost as they need not hedge or take exchange rate risks. This may help export recovery. Secondly, the switch will lower the growth in China's USD revenue. Combined with initiatives to allow foreign companies to issue CNY bonds and IPO, there will be a sharp slowdown in China's USD accumulation in the coming years. This will have a significant impact on USD, in light of the Obama Administration's expansive fiscal stimulus package (who will fund the US?). Thirdly, the plan allowed for a steady appreciation of the CNY. Over time, Hong Kong could benefit most and become the offshore center for CNY.

I see this development as a major turning point. Or is this a bluff? In a world driven (largely) by sentiments, once a major player like China turns gradually away from the USD, it opens the flood-gates for the oil exporting nations to do likewise. Hence, next to turn away (from USD) could be Russia, Middle East, Brazil etc. While the pace may be slow, it could finally spell the end of a strong USD policy. The ramifications will be significant.

Readers should read the publication or similar ones, to get the fuller picture. This is worth nothing.