Insight archive for Carmen Ling | Standard Chartered

Free trade zones – China’s stepping stones to freely traded renminbi

Carmen Ling — Thu, 26 Feb 2015 10:18:17 +0000

China is stepping on the reform accelerator, opening its capital account much faster than expected.

Just one year after launching its first free trade zone in Shanghai, China is now liberalising offshore borrowing for firms registered there.

The Shanghai free trade zone was originally billed as a three-year trial, but China is forging ahead, expanding Shanghai and launching three new zones on 1 March.

"The speed at which China is expanding the free trade zone scheme has come as a surprise to many observers"

While not the sole conduit for reform in China, the trade zone scheme is crucial to the prospects of a fully convertible renminbi (RMB), and the speed at which China is expanding the scheme has come as a surprise to many observers.

The recent announcement that offshore borrowing for firms in the Shanghai free trade zone will be relaxed further – and that the new regulation will include banks – is a significant breakthrough and suggests China is committed to achieving full convertibility of the RMB. Other pilot schemes are likely to follow.

Shanghai an important test bed

The latest policy changes follow China’s announcement last December that it would expand the pilot Shanghai free trade zone, by including sites such as the Lujiazui financial district, and establish three new hubs in Tianjin, Fujian and Guangzhou.

Launched in September 2013, the Shanghai free trade zone has been an important test bed in China for freer trade, and a more liberal business and financial environment.

"The Shanghai free trade zone is contributing to China’s financial reform"

The fact that China is now expanding the zone and replicating it in other cities confirms that the government considers it a success:

First, the zone is bringing real benefits to China’s economy and corporates. According to official data, export-import trade passed through the zone between January and August rose 11 per cent compared to the same period of 2013, before the zone was established.

Second, the Shanghai free trade zone is contributing to China’s financial reform. Initiatives such as cross-border RMB sweeping, which allows corporates to repatriate their trapped cash onshore to offshore – are crucial to promoting RMB internationalisation. Between January and August last year, two-way RMB flows arising from cross-border sweeping reached more than CNY27.2 billion.

More free trade zones a sensible step

Third, the risks associated with the zone are proving manageable. A negative list was put in place to restrict foreign funds from investing in specific industries within the zone, such as sensitive or overheated sectors. This list has since been shortened, demonstrating the Chinese government’s growing level of confidence in the zone.

Furthermore, commercial banks are enforcing know-your-customer procedures to ensure that the funds moving in and out of China are supporting genuine trade.

Bearing in mind this track record in Shanghai, launching new free trade zones seems a sensible way forward given China’s sheer size.

The Guangdong free trade zone, including Qinghai, will mainly serve corporates from the high-end financial services industry located in Hong Kong, the Pearl River Delta and Macau.

The Tianjin zone targets those located in the northern area, where some 80 Fortune 500 companies have established their presence, including many international multinational firms.

Meanwhile, the Fujian zone will make use of its strength on trade with Taiwan, and in the international logistics business.

"China is committed to driving financial reform in a bid to reach the endgame of full convertibility of the RMB"

While details have yet to be ironed out, the three zones are expected to implement similar policies to Shanghai, which will continue to cater for corporates in eastern part of China and overseas.

Corporates that have embraced China’s liberalisation via the Shanghai zone are befitting from first-mover advantage, but the free trade zones are not without challenges.

Many multinational corporates feel uncomfortable with the piecemeal and unpredictable way in which China announces its policy changes. Some are reluctant to set up an entity in a free trade zone, only to find another new, more user-friendly policy around the corner.

Expansion of zones will take time

In addition, RMB appreciation is no longer seen as a one-way bet, which poses an even bigger challenge for corporates as they will have to start hedging their RMB exposure.

Expansion of China’s free trade zones is likely to take time. Their scale will be small compared to the broader economy and it is unlikely that the zones will have a huge impact on activities beyond their boundaries.

What is clear, though, is that China is committed to driving financial reform in a bid to reach the endgame of full convertibility of the RMB, and more free trade zones will act as stepping stones along the way.

A version of this article appeared in the South China Morning Post on 25 February 2015

Renminbi internationalisation has passed the point of no return

Carmen Ling — Wed, 07 May 2014 23:00:44 +0000

‘Will renminbi internationalisation fail?’ and ‘What if China grinds everything to a halt?’ These were questions put to me by clients during my recent roadshow in Europe.

In contrast to the upbeat spirit in the past few years, recent news about the Chinese economy have focused on its departure from high-speed growth, the issue of shadow banking, and huge local government debts.

Nothing should be taken for granted after global financial crisis that sent shockwaves around the world in 2008, and it’s understandable that those far removed from the centre of the action should be concerned about the future of renminbi (RMB).

"RMB is on an irreversible journey of internationalisation. The only question is the speed of travel, not the direction"

However, it is important to keep things in perspective. There should be no doubt now that the RMB is on an irreversible journey of internationalisation. The only question is the speed of travel, not the direction.

Why? Because China’s leadership is determined to make it happen. Political push is one of the four key elements needed to internationalise a currency – along with deep financial markets, a sizeable economy and a sustainable growth trajectory – and, if you look closely, China does meet each of these.

Resolute political will

Beijing has exerted unwavering and resolute political will to carry out financial reform for the USD9.1 trillion economy. Over the past decade, we have witnessed the complete opening up of RMB trade settlement, the introduction of RMB clearing services to four cities worldwide, the establishment of 24 RMB swap lines with the central banks of other countries, and the proliferation of offshore RMB-denominated bond markets.

The list keeps getting longer, with the latest additions being the inception of the pilot free trade zone in Shanghai, the widening of the RMB trading band, the abolishment of the lending rate, and the Shanghai-Hong Kong Stock Connect share-trading programme.

To say that these policy changes have come about faster than expected is a vast understatement, and the response from around the world has been overwhelming.

Cities from New York and Toronto to Paris and Frankfurt have all expressed an interest in becoming the next RMB offshore centre, at least 40 central banks have invested in RMB and several others are preparing to do so. With so many countries trying to get on the bandwagon, RMB internationalisation cannot go wrong.

China’s financial markets have grown substantially wider and deeper in the last decade. As of the end of 2013, China’s A-share market capitalisation reached RMB23.9 trillion, and the bond market RMB29.9 trillion. It’s also important to take into account Hong Kong, a de facto proxy to China’s financial market, where the majority of dim sum bonds, worth a total of RMB291 billion, were issued in 2013.

RMB now ninth most traded currency globally

Moreover, the daily trading volume of onshore and offshore RMB foreign exchange – including spot, swap, forward and options – nearly quadrupled to USD120 billion between 2010 and 2013, making RMB the ninth most actively traded currency globally.

The latest cross-border stock-dealing initiative also opens up new doors for international investors to buy Shanghai-listed shares via Hong Kong, and Chinese investors to tap into Hong Kong-listed shares.

"Even if China’s growth slows, we would at most see stagnant or slower progress in RMB liberalisation, not a complete halt"

Over the past decade, China has quickly risen to the rank of the second-largest economy in the world, and it is on course to overtake the US, though whether it will sustain its growth trajectory is uncertain.

In the first quarter of 2014, China’s economy was still expanding well within the government’s expectation, albeit at a slower rate of 7.4 per cent. This supports the view that the economy is slowing, not collapsing, as China strives to sustain growth without running the risk of over-investing and -lending.

Even if China’s growth slows, we would at most see stagnant or slower progress in RMB liberalisation, not a complete halt.

More significant measures should be expected

Take the example of Japan: the yen lost momentum as a global currency following the 1997 Asian financial crisis, but a significant proportion of Japanese trade is still settled in yen and, at USD5.96 trillion, the Japanese economy is too big to be ignored by global trading partners.

China is almost double the size of Japan in terms of GDP, but so far only 17 per cent of its trade is settled in RMB, showing the tremendous potential ahead.

China has come a long way in the opening up of its capital account, but this is only the beginning, and more significant measures should be expected.

The internationalisation of the RMB has been set in motion, and all the evidence show that it has passed the point of no return. So while concerns are understandable, corporates can be confident in jumping on board.

A version of this article appeared in the South China Morning Post on 7 May 2014