Talks about the Chinese yuan challenging the U.S. dollar as the main currency store value have intensified over the past few weeks. For instance, France and China have completed their first LNG transaction in RMB and China and Saudi Arabia have agreed to build a refinery for 83.7bn RMB without any payment in USD.
While these developments are positive, iBanFirst analysts believe that it will take a major geopolitical and financial shift for the yuan to become a serious competitor to the US dollar in a reasonable amount of time.
Data shows that the China’s RMB sees trades worth 30bn USD every day, like South Africa. The USD does this every twenty minute. It would take China’s RMB 77 years to trade as much as the USD does in one year. We can also look at FX trading in each country, in any currency. In 2022, China traded as much FX as the US did in 1992 – so it’s 30 years behind (and probably more as this is in nominal dollars). Even adding Hong Kong, it will be decades before the USD loses its currency dominance. In conclusion, it is possible that the yuan will become a major currency, but it will take a significant period of time before it can compete with the US dollar.
The magic recipe
It is unlikely the RMB will replace the USD as the main currency store value in our lifetime. However, trade in RMB is doomed to increase further in the coming years. The growth in usage of the RMB in Europe is going gangbusters. Europe is second only to Hong Kong in cross-border RMB transactions – clearing about 10 % of the world’s RMB-denominated payments. Offshore RMB hubs have been established in London, Frankfurt and Paris and other European financial centers are lining up to grab a share of the growing trade (notably Warsaw in the CEE region). Looking at individual countries, Germany has led the way with about 10 % of its trade with China now settled directly in RMB, compared with less than 2.5 % in 2012.
What is perhaps more impressive is that the adoption of RMB is broad-based, both from large multinational organizations and SMEs. Broader use of RMB is facilitated by China with the establishment of bilateral swap lines with other central banks and the designation of offshore RMB clearing banks. In Europe, they are located in the United Kingdom, in Switzerland and in Hungary. Both policy measures helped to address offshore RMB liquidity shortages given China’s overall capital account restrictions, with the offshore clearing banks having a quantitatively larger impact. As of 2021 (latest data available), there are no People’s Bank of China swap lines with any CEE countries. But there is one with the euro area for 350bn RMB and another one with the United Kingdom for a similar amount, for instance. In Europe, Switzerland tops in third position with a swap line of about 150bn RMB.
Without much surprise, over the past decade, the RMB has also gained traction in Asian countries, such as Mongolia, Laos, as well as other emerging market and developing countries, such as Chile, Turkey, and Argentina. The swap line with Argentina amounts to 130bn RMB. Countries that were subject to U.S. dollar sanctions, such as Iran, also increasingly used RMB for transactions with China. Less control on China’s capital account is the next major step for a further internationalization of the RMB. But it is unlikely to happen anytime soon, especially in the current macroeconomic set-up where China needs to keep controls tight to avoid capital flight – basically in order to avoid the nightmarish scenario of 2015 when the country faced an unprecedented level of capital flight.
Four reasons to embrace payments in RMB
According to iBanFirst analysts, there is every reason to think that Europe’s RMB market share will continue to rise. European companies, notably importers, are working closer with China than ever, despite the Covid period, and there are strong incentives to bypass the USD/EUR/GBP or any other major currency to directly use the RMB. There are mostly four main advantages to accept transactions in RMB:
- RMB quotations are usually 2-3 % less expensive than EUR/GBP/USD/RON etc. For example, a company in China may add a “buffer” to its EUR pricing in order to mitigate its own foreign exchange risk, therefore indirectly exposing the European company to RMB foreign exchange risk and to a higher transaction cost. This “buffer” is noticeably higher than the current exchange rate and usually covers both administrative cost of transacting in EUR but also embedded premiums. By paying suppliers in RMB, foreign companies can protect themselves from greater FX volatility risk and it also creates more room for price negotiations. Ultimately, this improves business relationships between both partners by keeping prices more stable and more foreseeable.
- A FX expert, like Ibanfirst, can negotiate on behalf of his clients and it can explain to the Chinese counterpart why it would make sense to switch to RMB. Though it happens less and less, many Chinese companies still prefer to be paid in USD, often to source some raw materials from abroad. A FX expert can also negotiate a better RMB rate compared to the current market spot rate. On top of this service, it can provide risk management tools which are needed to address the Chinese market as well.
- European company subsidiaries in mainland China typically use the RMB as their functional currency. As a result, conducting intercompany lending/borrowing, profit repatriation, registered capital injection, etc., between European companies and their subsidiaries in RMB allows their currency risk to be centrally managed by the parent company through foreign exchange hedges or multi-currency accounts (MCA).
- European businesses can now invest very easily their potential RMB earnings in RMB-denominated financial instruments managed by European banks (i.e., the China Europe International Exchange based in Frankfurt which is the main European trading venue for RMB-related investment products outside the mainland). This includes ETF (pooled investment security that tracks a particular index, like the main UK stock index the FTSE-100), bonds, ETF derivatives (this is a category of ETFs that use derivative instruments such as futures and forward contracts, swaps, options and even the use of debt to bet on the price movement of specific underlying assets) and D-shares (shares issued offshore by Chinese companies), for instance.
Switching to RMB is easy as well. There is no special procedure for European companies to conduct cross-border payments in RMB. This can be easily done through EUR demand deposit accounts or through multi-currency accounts. There is no need to include a payment purpose code either. There is therefore no reason not to accept paying in local currency. For companies in mainland China, it is slightly more tedious (activation in the RMB Cross-Border Payment Management Information System, local banks will require supporting documents that demonstrate the background of the payment etc.). But this is manageable.
Looking forward, iBanFirst analysts are optimistic and expect RMB-denominated transactions in Europe will continue to grow and reach 20 % perhaps in five years’ time. If China even accelerates the opening of the economy (especially of its current account), it could even go faster. At a certain stage, it will certainly not even make sense to use USD, EUR or GBP for doing business with China.