Before the Covid-19 pandemic, China’s renminbi (RMB) had been gaining ground to become one of the world’s top five reserve currencies. And despite the shock of the outbreak, its rise in prominence is set to continue. So how will the ongoing internationalization of the RMB change the global financial landscape, and how should investors respond to these changes to capture the opportunities they bring?
First things first, though; the trauma of the first few months of this year has had a major impact on the RMB’s near-term outlook in terms of interest rates and on the forex market overall. The shock of Covid-19 has pushed Chinese bonds into bullish territory, with yields for both short- and long-dated paper sinking sharply.
A steep yield curve for Chinese government debt may persist in the near-term period and yields will fluctuate widely, according to a RMB Interest Rates Specialist at Industrial & Commercial Bank of China (ICBC), one of the world’s largest lender by assets.
At present, offshore investors will continue to increase their RMB bond holdings, which the ICBC Rates Specialist sees as becoming more attractive, thanks not only to money-market rates remaining stable and to high US-China spreads but also to index inclusion and further enhancement when it comes to investing in the Chinese interbank bond market.
The RMB forex rate will continue to fluctuate amid the resumption of economic activity in China but will be broadly supportive of the currency, as will renewed risk appetite among investors and the historical low levels of absolute yields.
Nevertheless, challenges remain for the RMB. China’s growth and development has been exceptional, but it hasn’t been matched by the adoption of the RMB as a global payments currency (it placed sixth this year1–one notch below compared to 2018).
The gap between China’s trading power and the use of its currency for settlement and payment suggests there is huge potential for the internationalization of the RMB, and that its use will increase – from a trade settlement currency to an investment currency to a reserve currency.
Yet during the past few years there has been a steady ramping up of pressure on China, particularly related to US-China trade, to say nothing of the more recent tensions generated by the Covid-19 pandemic.
These factors, perhaps somewhat paradoxically, are likely to push China to open up its currency even more, according to Patrick Tekely, Vice President, Asia Pacific FX Product Management at BNY Mellon Markets. Investors have been calling on Chinese regulators to introduce hedging tools as they scale their portfolios in China and seek to manage more complex risks – and the regulators are heeding those calls amid an overall push for integration of Chinese capital markets with the rest of the world.
The RMB’s use is likely to remain restricted during the next couple of years, but the People’s Bank of China (PBOC) is undertaking reforms in this respect. Patrick views that the central bank will continue to promote investment class flows, but immediate attention to easing capital repatriation and the ability to efficiently trade with multiple FX counterparties would prove beneficial. Greater clarity on hedging rules and the legal agreements required between investors and forex counterparties would likewise be welcome.
Going forward, there are both micro and macroeconomic factors to consider, particularly issues involving the US-China trade relations.
“Given the fact that 2020 is a presidential election year in the US, the hawkish tone adopted by the US towards China is likely to continue, which may have consequences for China’s economy,” said Michael Huang, Head of FX Sales China at BNY Mellon.
Other developments will involve the pace of China’s economic rebound, and the dynamics of global export flows in markets in which China is a player.
Global investors should lean on their service providers for advice and expertise in navigating the RMB market, while also staying up to speed on new market reforms and developments in various access schemes. As the RMB will inevitably continue to open up, ultimately global investors should continue to build their capabilities in accessing the world’s second largest capital market.
1 SWIFT RMB Tracker June 2020
The views expressed herein include external speaker and may not reflect the views of BNY Mellon. This does not constitute legal, tax, accounting, investment, financial or other professional advice on any matter and does not constitute a recommendation by BNY Mellon of any kind.
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