Renminbi's use in trade finance will increase significantly over the next three to five years, according to an Aite Group report titled "Internationalization of the Renminbi: Weaving a Web for the Redback."
The report says that the size of China's economy and its role as a leading power in imports and exports should mean that the renminbi will gain significant traction in the universe of trade invoicing and settlement, which will later be followed by its use for global payments, especially for cross-border Asian transactions, and, in the longer term, by its use as an offshore investment currency.
"Despite domestic regulatory restrictions continuing to hamper the renminbi's investment currency prospects overall, the renminbi's use in trade finance will increase significantly over the next three to five years," says Virginie O’Shea, senior analyst in Institutional Securities & Investments at Aite Group.
Despite this, in the short term, the lack of deep and liquid domestic financial markets, a tight financial market and capital account, and limited exchange rate flexibility continue to hold back the renminbi's prospects as an investment and reserve currency.
Financial sector reforms need to continue to liberalize the capital account and strengthen the flexibility of China's exchange rate, as well as ease restrictions on foreign investment in the domestic market, to keep the liberalization of the currency and financial markets on track.
A broadening of the range of renminbi-denominated assets will foster growth of the onshore capital markets and the currency's prospects globally.
The development of renminbi-denominated products such as equities, mutual funds, money market funds, and insurance products is vital for the renminbi's prospects as an investment currency.
Aite Group's survey for the report found that there are mixed opinions on offshore center development in Europe, with many believing cooperation will be important for future growth in liquidity.
Some firms are convinced that one particular center will dominate; more than half of respondents believe Europe as a whole will eventually cooperate to foster offshore liquidity in renminbi; and a minority (13%) feels that Europe will fail to garner sufficient liquidity and that Hong Kong or another Asian hub will prove more attractive.
Many firms active in renminbi and the Chinese market anticipate that 2020 could be a key date for achieving convertibility and internationalization.
The percentage of total global trade value settled in renminbi rose from 1.9% in January 2012 to 8.7% in October 2013 (compare that to the U.S. dollar's decline from 85% to 81.1% during the same period), and Aite Group expects similar levels of growth during 2014.
Aite Group estimates that by year-end 2014, total issuance for the year will be RMB554 billion, up from RMB375 billion last year. The majority of survey respondents (87%) believe that dim sum bonds are "appealing."
A majority or 87% of interview respondents believe that the Chinese onshore market's lack of sophistication and the restricted number of products (offshore and onshore) has held back the renminbi's internationalization process.
Challenges remain in the trade finance and payments space due to factors such as a lack of clearing broker readiness for operating in renminbi (32%) and translation issues (32%), according to survey respondents.
"The renminbi has already made some headway in adoption as a global currency for trade finance," says Virginie O’Shea, senior analyst in Institutional Securities & Investments at Aite Group.
O’Shea notes that the size of China's economy and its role as a leading power in imports and exports should mean that the renminbi will gain significant traction in the universe of trade invoicing and settlement in the next three to five years.
"This will be followed by its increased adoption as a regional Asian payments currency, and, later, as an investment currency via offshore investment in instruments such as dim sum bonds," adds O’Shea.