Will the Chinese Renminbi Become the New Dollar?

NEW YORK (TheStreet) -- As topics go it's a pretty hot one and frequently debated in the foreign exchange community: Just when will the Chinese renminbi -- also known as the yuan -- becomes fully convertible and freely tradable?

This has been vexing the minds of academics, politicians and FX market participants alike.

While it took the U.S. dollar around four decades to replace the sterling as a global reserve currency, the pundits are speculating the renminbi could become fully convertible within the next few years and a base currency for commodities. The signs bode well, albeit with caveats.

Global bank HSBC, a heavyweight player in Asia, issued a briefing note in early 2013 saying it expected "the renminbi to become a top three global currency for trade settlement by 2015 and to be fully convertible in five years."

By then it could be one of the world's most traded currencies and on a par with the U.S. dollar and euro. Currently, the renminbi's value is pegged against the U.S. dollar, allowing only modest changes. It is measured against a basket of currencies, mainly the dollar, the euro, Japanese yen and South Korean won. The daily trading price of the renminbi against the dollar is only allowed to float within a narrow band of 0.5%.

Nevertheless, some might have a feeling of deja vu given the Chinese authorities attempted to make the currency fully convertible before in the late 1980s and early 1990s. But with the onset of the Asian financial crisis those plans were seriously postponed in 1996 and made Chinese policy makers extremely cautious.

Chinese policy makers fear that a nationwide liberalization of capital and currency controls would spark a cash exodus. Indeed, according to a recent Hurun report 44% of Chinese individuals holding over RMB10 million (c.U.S.$1.65 million) in their names have plans to emigrate. Hot money flows are also a concern, whereby money is invested to reap short-term profits on interest rate differences between countries.

While HSBC has been impressed with the renminbi's "rapid internationalization" over the past two to three years and the significant progress made, it believes China still has a long way to go before the renminbi is fully liberalized and becomes a world currency.

Some commentators believe the internationalization has been far faster than expected. Indeed, according to HSBC's report, today more than 10,000 financial institutions transact business in the renminbi, up from just 900 in June 2011. Over the past 10 years, the currency has risen by more than 35% against the dollar and sterling.

While Chinese nationals are not entirely free to take money out of the country, in reality many are trying to do so illegally and using underground banks. At present the investment cap is set to $50,000 (c. 30,000 British pounds) per annum. But illicit transfer of funds comprising hundreds of billions leave China, according to the Wall Street Journal, and made it through Hong Kong with less-stringent capital controls.

As the renminbi is not yet fully convertible, the Chinese government has in recent years promoted an offshore market where the currency can be used outside the Chinese mainland. To further open up the currency for cross-border transactions, special administrative zones are being established such as the Shanghai Pilot Free Trade Zone (PFTZ) -- effectively the "hole" in China's currency wall. Here full convertibility is allowed but on a small scale and under certain circumstances.

According to financial guidelines published recently by the People's Bank of China titled Opinions on Leveraging the Role of Finance in Supporting the Construction of China (Shanghai) Free Trade Zone (December 2013), residents in the PFTZ can set up "resident free-trade accounts" in domestic and foreign currencies. Renminbi under these accounts will be fully convertible "when conditions are ripe." Other reforms within the PFTZ revealed in PBC's document are designed to further facilitate cross-border currency flows.

Provinces like Tianjin and Guangdong are also seeking permission to set up special trade zones to benefit from more relaxed cross-currency restrictions. If reforms in the special zones are rolled out nationally across China, the renminbi will in effect become fully convertible and a global currency, as HSBC predicts.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

Tom Williams is an account manager and foreign exchange broker at GO Markets, a provider of online foreign exchange trading services. Contributing to GO Markets and a number of leading online publications, including Futures Mag, FX Empire, FX Street and Bullbearings.

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