TCG’s first article in “The Rise of the Renminbi” series, in which we explore the costs and benefits of China developing a global currency, can be read here.
China has employed a series of multilateral economic programs to set the scene for increased RMB integration into cross-border payments and investments. Most prominent among these is the “One Belt, One Road” (OBOR) initiative, a large-scale cooperative that seeks to expand infrastructure financing for developing countries.
While OBOR extends across many facets of international trade, its massive loan programs are intended to form an early-stage network of RMB-using nations through infrastructure projects and cross-border trade. A 2017 report conducted by China Construction Bank surveying 398 Chinese and foreign enterprises and financial institutions found that 72% of all respondents and 80% of Chinese companies thought that OBOR has had the biggest impact on RMB internationalization. However, complications relating to China’s capital account management, restrictive market practices, and the stability of major currencies within the global financial system have presented significant obstacles to Beijing’s ambitions for a fully-fledged international RMB.
What is ‘One Belt, One Road?’
OBOR is a large-scale economic initiative that aims to improve cooperation between China and participating nations through trade, investment, and infrastructure – also known as the “trinity of aid.” At the same time, China’s approach to provide assistance via economic development is closely aligned with its own economic ambitions. The program is touted as a “win-win” to member nations and attempts to “break the bottleneck of Asian connectivity” through the promotion of large-scale infrastructure projects.
OBOR was first introduced by President Xi Jinping at a conference in Kazakhstan in 2013. He spoke of an infrastructural and economic revival of the Silk Road – the ancient trade route that extended from China across Eurasia to modern day Egypt and Europe. The project was one of the largest economic development initiatives ever conceived; then, a month later in Indonesia, President Xi proposed an additional maritime route that would loop through the Indian Ocean around to Eastern Africa. The “Road” was later officially titled the “The Silk Road Economic Belt” and the “Belt” was later named the “21st Century Maritime Silk Road.”
The Belt and Road spans Asia, Europe, the Middle East, and parts of Africa, and the nations that fall within its perimeter are eligible to participate in the initiative. To further regional economic collaboration, the program carves out “economic corridors” that are defined by critical infrastructure links such as railroads, energy pipelines, and ports. Since its announcement, OBOR has expanded into over 78 nations across the globe.
At the core of the initiative is lending. China provides significant levels of development funding to its partners for projects relating to infrastructure, energy, and industry. Similar to other forms of Chinese aid, the financing most often comes in forms of preferential loans, and terms typically stipulate that partner nations must use the capital to hire Chinese construction labor to build railways, bridges, and ports. As China distributes higher levels of development funding, more nations will join a strong global trade network – with China at the center. To date, the total sum provided to member countries has surpassed US$200 billion, with some estimates as high as US$1 trillion.
OBOR as a Driver of the RMB
OBOR focuses on the ‘five connections’: infrastructure, investment, trade, capital, and people. Infrastructure, investment, and trade form the ‘trinity of aid,’ wherein China aims to supply development finance for infrastructure projects. This in turn drives stronger global economic ties through which Chinese companies can boost outbound investment, while foreign firms gain increased access to Chinese goods.
These three tenets also set the scene for heightened RMB usage along the “Belt” and the “Road.” Many of the financial instruments used in OBOR lending are denominated in RMB, while China’s “Cross-Border RMB Trade Settlement Framework” allows all trade along the Road to be settled in RMB. Additionally, as China continues to incrementally open its capital accounts to more flows by way of RMB foreign direct investment and RMB outward foreign investment schemes, investment along the Road can also be invoiced and settled in RMB.
OBOR’s size and targeted geography further amplifies the significant opportunity for economic growth – and by extension, the rise of the RMB. Countries included in OBOR compose roughly 55% of global GNP and 70% of the global population and contain many of the world’s most rapidly growing economies. While these nations boast large labor forces and vast natural resources, underfunding and underinvestment have inhibited them to reach their full development potential. A 2019 World Bank report expressed that “trade in [OBOR] corridor economies is estimated to be 30% below potential, and FDI is an estimated 70% below potential.” Cognizant that many recipient countries of OBOR loans tend to be underexposed to regional and global markets, China created an opportunity to boost its currency’s global influence by providing RMB-denominated loans and using the RMB to capture any subsequent trade increases from these economic revitalization efforts.
Globalization Along the “Belt” and the “Road”
RMB-denominated Infrastructure Financing
Beijing has established massive development funds and held bond offerings in overseas markets to ensure its development projects have sufficient liquidity. Originally established in 2014 with a starting value of US$40 billion, the Silk Road Fund is a state-owned investment fund with the sole purpose of financing OBOR projects, and received approximately US$100 billion in 2017 to encourage RMB-denominated outbound investment. While the funds are in place, a large portion still remains unallocated to date.
Sino-Pakistani trade has unlocked an important milestone for the RMB. As China’s largest investment recipient in South Asia, Pakistan announced in a 2019 agreement that all China-Pakistan Economic Corridor (CPEC) development loans would be issued in RMB. While these plans have yet to materialize, once achieved, it could ostensibly open the floodgates for rapidly increasing global RMB usage. At present, the RMB only accounts for 5% of total Sino-Pakistani bilateral trade due to the currency’s illiquidity within Pakistani markets. Pakistan maintains a trade deficit with China, which contributes to persistently higher RMB outflows than inflows each year, and results in diminished opportunities for additional RMB-based trade and investment. As a significant global exporting country, China runs trade surpluses with most nations across the globe. As such, Beijing intends for OBOR to disperse the RMB across the globe through project financing to resolve market liquidity issues similar to that of Pakistan and pave the way for increased RMB-based trade.
In addition to centrally-backed investment funds, major Chinese banking organizations have also begun offering “dim sum bonds,” or RMB-denominated bonds sold in global financial hubs like Hong Kong and London to finance infrastructure loans. Notably, the Agricultural Bank of China debuted a US$1 billion dual currency bond in London in 2015, offering a green bond to finance sustainable land use and renewable energy development. Financing projects with the RMB, particularly through bond issuances, serves to create pools of RMB liquidity abroad and releases the currency from stringent capital controls seen within the domestic Chinese market – though “offshore RMB” totals would be insufficient to cover the hypothetical needs of OBOR-related RMB trade as exemplified by Pakistan.
Dim Sum Bond Issuances
However, RMB-denominated bond offerings abroad have begun to slow. With increased foreign investor access to Chinese markets through reforms like the amended RMB Qualified Foreign Investor Initiative (RQFII), dim sum bonds are losing their long-term appeal. Diverging exchange rates between the onshore (CNY) and offshore (CNH) RMB have driven foreign investors to approach the domestic market directly through “panda bonds” – yuan-denominated bonds onshore bonds available to RQFII participants, with the total volume of panda bonds surpassing that of dim sum bonds by 50%. However, onshore bonds are failing to drive RMB adoption across OBOR nations; instead, the vast majority are issued by Western MNCs to bolster cash for operations and Chinese market expansion.
That said, the RMB is still beginning to gain traction. On April 1st, 2020, the first RMB-denominated bond was issued in Kazakhstan, marking the first issuance in all of Central Asia to support OBOR-related infrastructure projects. To further develop the offshore RMB market, one of China’s “big five” banks, China Construction Bank, opened a central location in Kazakhstan’s capital city of Nur-Sultan in September 2019. The integration of Chinese financial institutions into Kazakhstan’s markets, coupled with the country’s “de-dollarization” strategy and a 30% local currency devaluation in 2015 will further advance the RMB’s adoption as a common currency within the country’s markets and provide a model for RMB liquidity in OBOR markets.
RMB-denominated International Payments
As China rolls out its grand strategy, Beijing has focused on establishing a robust system for currency conversion and flow. China has begun to designate RMB clearing and settlement banks in nine OBOR countries to facilitate the use of RMB for cross-border payment settlements, which is intended to in turn spur heightened bilateral trade and investment dealings. Additionally, the establishment of offshore Chinese bank branches, such as the Bank of China and the Agricultural Bank of China in 64 OBOR countries helps influence the RMB’s exposure to cross-border trade, with these institutions providing easy access for importers and exporters to swap local currencies for the RMB, assuming sufficient market liquidity.
Financial Institutions Facilitating RMB Payments
The areas where OBOR is prevalent – including Africa, the Middle East, and ASEAN member nations, are leading the way in RMB payments’ growth in trade and investment. Between 2017 and 2019, Middle East and North Africa (MENA) countries saw a 21.0% expansion of financial institutions using the RMB for payments. Increased Chinese trade influence in the region has been driving the RMB’s growth. Since 2018, China has been the Gulf Cooperation Council’s top economic partner and the largest trading partner of Kuwait, Saudi Arabia, and the UAE, with the UAE in particular facilitating more than 80% of all payments with mainland China and Hong Kong in RMB. To avoid any potential future RMB liquidity issues within the region, China is working to develop the UAE into an offshore RMB hub and, in 2017, the Agricultural Bank of China established a clearing center in Dubai.
The Chinese-ASEAN trade relationship has also scaled dramatically in recent years. In 2019, trade volume with ASEAN climbed by 14% to CN￥4.43 trillion to overtake the US as China’s second largest trading partner. The robust growth is expected to continue, notably in the technology sector as Chinese internet conglomerates like Baidu and Alibaba increase their presence in Southeast Asia under the support of OBOR. Additionally, an initiative called the ASEAN-China Strategic Partnership Vision 2030 was signed in 2018, with the commitment of increasing the two-way trade volume to the tune of US$1 trillion by 2020. As of May 2020, Singapore has been the most active RMB user among the group, handling nearly 4.5% of global RMB payments and trailing only Hong Kong and the UK. To further translate trade growth into practical gains for the RMB, the ASEAN +3 (China, Japan, South Korea) have recently been discussing adding the yuan into their current US$240 billion currency swap safety net.
However, OBOR adoption of the RMB is still only slightly outpacing that of non-member nations. At the end of April 2020, 72% of total RMB payments were still limited to Hong Kong, pointing to comparatively lower RMB settlement totals in the rest of the world. In 2017, the deputy governor of the People’s Bank of China Yin Yong noted, “there are more than 50 Belt and Road economies where the proportion of renminbi usage in cross-border transactions is lower than 5 percent.” RMB use between OBOR members (excluding China) is even lower, with intra-ASEAN trade (excluding Singapore) in 2015 only accounting for 0.32% of all RMB settlements in Asia. This implies that there exists significant potential for increased RMB usage in OBOR economies, but that usage thus far has been limited.
OBOR and an international RMB are two separate initiatives that coalesce to mutually complement each other. As the RMB’s international influence grows, China will play a stronger role in shaping global financial policy in a similar manner as the US does in the modern global financial system. While the USD and RMB still hold significantly different roles in the global economy, it is clear that China is taking active measures to expand the RMB’s influence. Should the West continue to undermine its global economic leadership through isolationist trade policies, RMB-denominated cross-border transactions through OBOR and other Chinese-led international trade initiatives will scale as countries across the globe begin to turn to China. While the road ahead remains long for an international RMB – the first steps have been taken.