China's RMB

Historically, China’s centralized policies limited the size and scope of the country’s economy. China’s emergence as an economic and political power, evidenced by a projected GDP growth of 9.8%, overtaking Japan as the world’s second largest economy, and consuming more energy that the United States, has forced its government and banking system to re-evaluate long-held policies. One example of this is the treatment of the national currency, the renminbi (RMB), commonly known as the yuan. The Peoples’ Bank of China (PBC), China’s central bank, set strict convertibility restrictions on the RMB, minimizing its use outside of China and creating a black market in currencies. This limited China’s growth and left the RMB an unsophisticated means of exchange.

With China’s economic rise, however, the RMB is set to become more prominent in international transactions. Recent policy changes from the PBC have made the RMB more valuable in commercial settings, increasing the likelihood of its future use in international transactions. In 1994, the PBC pegged the RMB to the US dollar; this made China’s currency susceptible to dollar fluctuations and other risks in US monetary policy.

China has now removed the peg to the dollar and is tying it to a portfolio of international currencies. This, in turn, has lead to currency swaps with several nations, and to calls for moving the global monetary system away from the US dollar as a reserve currency. Along with appreciating the value of the RMB, such moves have opened up, albeit slowly, new opportunities for investment, both inside China by non-Chinese entities, and outside of China in the form of foreign direct investment.

This means several things for the importer and those procuring goods and services from China. First, there will be a greater possibility of using the RMB exclusively in trade transactions. While this is still not reality, over the next several years this practice could expand. Manufacturers in China could begin quoting prices and conducting entire transactions based on the RMB. Chinese companies can use this to avoid the risk of currency fluctuations in the time between agreeing on price, finishing production, and shipping goods to customer. Increasing the sophistication and maturity of the Chinese banking system could also lead to a revaluation of the RMB, and increase in its value relative to other currencies.

The downside for importers and sourcers is that this could drive up production costs, but also can provide some bargaining power for US companies to gain more favorable payment and financing terms. As the RMB matures, and reflects China’s move towards greater liberalization and transparency, it is likely that the RMB will accelerate its growth towards becoming an international currency. As it becomes more widely accepted, companies can expect to see greater sophistication of the RMB as a financial instrument, and will likely encounter its use in transactions with greater frequency.