If you build it, he will come. In this case, “it” is not a baseball diamond, but a renminbi (RMB) hub, and “he” is not Shoeless Joe Jackson, but rather a business community eager to trade and invest in RMB. So far, the “build-it-first” approach has paid dividends for Hong Kong, London, Taipei, and Singapore. Frankfurt, Luxembourg, Seoul, and a host of other jurisdictions are also showing initial promise after recently signing hub agreements. But will this approach work for Canada?
First off, we do not have a hub, but let’s assume for a moment that one will be established that includes all the usual bells and whistles. This would typically include the designation of a local clearing bank by Chinese authorities that can settle transactions locally in RMB, a bilateral swap agreement between the central banks, and direct trading between the RMB and the Canadian dollar (rather than having to loop RMB trades through USD).
It is noteworthy that those quick to establish hubs each have unique advantages. Hong Kong is the historical epicentre of RMB activity and is intimately tied into the mainland economy. London is the global capital of foreign exchange trading. Taipei has more than 80,000 foreign affiliates on the mainland, not to mention about three million RMB-carrying tourists per year. Singapore is the window through which Southeast Asia engages China, and is a centre for corporate treasuries in Asia.
Canada does not enjoy any of these benefits, but the logic for an RMB hub is nonetheless strong, particularly concerning trade payments. First and foremost, China is now one of our most important trading partners. In fact, with just under $73 billion in two-way merchandise trade in 2013, or eight percent of Canada’s total trade, China stands alone at number two on the list. This means that all of the standard incentives for RMB- denominated trade apply in spades for Canada. The most important of these are the cost savings on foreign exchange transactions, the wider universe of Chinese clients that may be accessed, and the price discounts that can be negotiated into import and exports contracts. Moreover, a hub would allow Canada’s financial sector to develop a deeper pool of RMB liquidity. This has been the experience across Asia and Europe after hubs were established and it is a first step toward the creation of critical infrastructure, such as a flexible RMB derivatives market.
A second key factor is the awareness effect generated by the buzz that always surrounds the establishment RMB hubs. While many of Canada’s big players are already aware of the potential benefits of direct RMB trading, and are preparing themselves for it, this is not always the case with small and medium-sized enterprises (SMEs), which do not have as many resources to devote to the latest foreign exchange strategies. The risk here is that Canada’s SMEs could be caught off guard by a rising renminbi and wind up losing some of their competitive edge as competitors in Australia, Germany, the United Kingdom, France, South Korea and elsewhere try to increase their market share by offering RMB denominated contracts.
So far this has not happened because the most likely source of demand for RMB denominated trade—the Chinese trader—still prefers to settle contracts in USD. The main reasons for this are the predominance of USD in global value chains, the low cost of the dollar, expectations that the RMB will get back onto the appreciation curve, and the limited nature of the RMB derivatives market. Simply put, denominating contracts in greenbacks allows Chinese companies to simplify their supply chain business, reduce foreign exchange risk, and raise financing on the cheap.
Of course, this scenario will not last forever, especially when it comes to cheap dollars. Structural weaknesses elsewhere, higher US interest rates and a general global preference for greenbacks all suggest a more expensive medium-term USD.
The bottom line? At least three realities regarding the RMB’s internationalization process are clear: first, it is ongoing and irreversible; second, it will have important implications for the global economy; and third, Canada’s competitors are already adapting and learning how to embrace it. Translation, Shoeless Joe is getting ready to play ball. Will we be ready for him?
More commentary from Peter G. Hall