The Renminbi Zone

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

CURRENCY

The Renminbi Zone

Driven by the country's economic success and with quiet support from
Beijing, China's currency is more and more welcome across the region for
business and tourism. And it could be on its way to a much bigger role
in Asia

By Michael Vatikiotis/HONG KONG and Bertil Lintner/CHIANG MAI

Issue cover-dated May 29, 2003

SOMETHING SURPRISING is happening to China's currency. Although not
fully convertible, the renminbi, the "people's money," is growing in use
as a hard currency outside China--the first sign of its potential role
as "Asia's money." In Hong Kong and along China's borders with Southeast
Asia, an emerging renminbi zone can be traced, fuelled by burgeoning
Chinese trade and tourism.



WHAT GIVES THE RENMINBI REACH
• The growth of China as a market and export base
• Beijing's drive to deepen its trade ties with Asia
• Growing renminbi use in areas bordering China
• Full convertibility is an eventual goal for Beijing
• Rising domestic demand

In Hong Kong, which has its own currency pegged to the United States
dollar, the renminbi is used to buy goods at electronics stores in the
busy shopping areas of Kowloon. At some automated teller machines in
Hong Kong, customers already have the option of withdrawing renminbi or
Hong Kong dollars. Mainland banks in Hong Kong issue
renminbi-denominated credit cards. Fewer Chinese who travel exchange
renminbi for foreign currency before leaving China--as they're supposed
to. Instead, they do so at their destinations. The renminbi is, for
instance, listed among exchange rates of hard currencies at Chiang Mai
airport in northern Thailand. More than 16 million mainland Chinese went
abroad in 2002. The renminbi is also increasingly used in commercial
transactions across wide stretches of Southeast Asia close to the
Chinese border.

"China is effectively managing a hard currency," says Michael Kurtz,
chief analyst for Bear Stearns in Hong Kong. "The move is almost
effortless, backed by solid reserves and wise economic policies." What's
more, adds Steve Xu, a Chinese economist in Hong Kong, "this is all
driven by market forces, not a deliberate policy."

The rise of the renminbi is a quiet result of the rapid growth of
China's economy, and a conscious effort by the government in the past
few years to deepen trade ties with the rest of Asia. The International
Monetary Fund estimates that 40% of total trade within non-Japan Asia is
intra-regional, and trade with China accounted for 40% of the increase
in 2002. As well as reflecting China's growing economic influence in the
region, experts say that Beijing is counting on the currency acting as a
strategic tool to consolidate China's power and influence in Asia,
possibly paving the way for the renminbi's debut as a regional reserve
currency. Chinese Prime Minister Wen Jiabao said recently that a strong
and stable renminbi is good for Asia.

Annual growth rates in China of about 8%, boosting regional trade and
tourist flows, seem to be achieving such an aim. Some experienced
financiers worry that sceptics may be ignoring a dawning reality. A
particularly strong advocate of the currency is John Wadsworth, an
advisory director of Morgan Stanley based in San Francisco. "The
renminbi will be free to trade, it will be a strong currency, Chinese
banks will be dominant, and it is highly likely that there will be four
major currencies in the world within 10-15 years," he says. Adds Edward
Zeng, CEO of Sparkice, a leading Beijing-based electronic-commerce
company: "It amounts to a gradual move toward convertibility."

The authorities in Beijing tentatively support this development. Guo
Shuqing, a deputy governor of China's central bank and the chairman of
the State Administration of Foreign Exchange, told local media in March
that the government's attitude "is both supportive and cautious" about
the increasing internationalization of the renminbi.

Guo estimated the total amount of renminbi in circulation outside China
at greater than 30 billion renminbi ($3.6 billion). "Not only in
neighbouring countries, but even in the United States, there are places
for the exchange of renminbi. The circulation of renminbi demonstrates
confidence in the Chinese economy," Guo said.

China's membership of the World Trade Organization only accelerates the
emergence of a strong, unified Chinese currency. This, in turn, will
increase the desirability of a fully convertible renminbi, both as a way
of smoothing the integration of China's economy into the world economy,
and as a way for China to exercise its economic might more directly.
Full convertibility is a stated goal, but no fixed timetable has been set.

The renminbi's gradual emergence is consistent with past Chinese
experiments in economic and political reform. "Since China trade is
becoming an important part of intra-regional trade, China will be happy
to see the renminbi used," says Andrew Freris, chief economist at BNP
Paribas in Hong Kong. "China turns a blind eye to all this and sees an
upside in terms of acceptance of the currency," concurs a senior
economic adviser at HSBC in Hong Kong.

This willingness to experiment could explain why a blind eye is being
turned to the flouting of foreign-exchange restrictions normally applied
to Chinese citizens travelling abroad (officially there's a limit of
6,000 renminbi each). The renminbi is already in wide circulation in the
countries favoured by Chinese tourists in Southeast Asia, principally
Singapore, Malaysia and Thailand.

For its part, Hong Kong is open to increased use of the renminbi to buy
goods and services. Joseph Yam, chief executive of the Hong Kong
Monetary Authority, says the city as an international financial centre
in China should "capture any international financial intermediation
activities denominated in renminbi." A spokesman for Hong Kong's
Financial Services and the Treasury Bureau says: "The growing use of
renminbi in Hong Kong is a natural development along with the financial
integration between Hong Kong and the mainland." Economist Xu, a
research fellow at the Hong Kong think-tank Civic Exchange, estimates
that renminbi worth HK$30 billion-40 billion ($3.8 billion-5.1 billion)
is in circulation in the territory.

Then there's the growing use of the currency in areas bordering on China
that increasingly rely on cross-border trade. For now, the heart of this
creeping renminbi zone is focused on some of the region's most marginal
economies. The renminbi is the principle trading currency in northern
Laos and northern Burma as far west as Mandalay and south to Kentung,
just 150 kilometres from Thailand. It is also widely used for business
in Cambodia and Vietnam. According to some reports, the renminbi is
being hoarded as a hedge against inflation in Cambodia, alongside the
dollar.

In Burma and Laos, the Chinese currency is a hard substitute for weak
local currencies like the Burmese kyat and Laotian kip. The blackmarket
rate for the kyat is as low as 1,000 to the dollar, from 250-300 in
1997. The official rate of the kip has slipped from 960 to 10,500 in the
same period. More conveniently, the renminbi can be used for purchases
and any kind of deal across the Chinese border.

Cross-border trade has increased in recent years. Consumer goods,
machinery and fruit come in from China; timber, minerals and smuggled
cars leave Burma, Laos and Thailand. All these transactions, amounting
to hundreds of millions of dollars in annual value, are settled in
renminbi--greatly helped by lax controls over carrying currency in and
out of China. An official from the Yunnan provincial government told a
recent Asia Society conference in Hanoi that more than a million people
crossed the border with Vietnam in the previous 15 months.

Along the Thai banks of the Mekong River, Chinese traders from Yunnan do
business without converting their renminbi into Thai baht. All over
Thailand, an underground banking network enables traders to transfer
funds in and out of the Chinese currency. A similar system works in the
Pearl River Delta region connecting Hong Kong with Guangdong province.
Says Marc Faber, one of Asia's most experienced financial analysts: "The
renminbi is the strongest currency in Asia right now; the problem is
there isn't enough of it in circulation."

It's a curious situation because the renminbi is still subject to rigid
capital controls. Regional central banks will not hold the renminbi as a
reserve currency, nor do they issue debt in renminbi because China keeps
it to a de facto peg of nearly 8.28 to the dollar. The renminbi is not
freely convertible on the capital account, and most analysts don't
expect this to change for some years. The fear is that opening the
country's capital account too soon will lead to huge outflows because of
a lack of confidence in the banking system.

Of course, China has already used its currency to play a leading
regional role. Pledges to maintain a stable renminbi were a key source
of confidence for Southeast Asia during the 1997 financial crisis. China
signed currency-swap agreements as part of an Asia-wide currency safety
net under the Chiang Mai Initiative, designed to ward off future
financial crises. China's $300 billion in foreign reserves are the
second-largest in the world and will likely play a central role in a
planned Asian bond market quietly backed by Beijing. China and the
Association of Southeast Asian Nations have agreed to form a free-trade
area within a decade.

In the longer term, these developments foreshadow what some experts see
as the evolution of the renminbi into a regional currency floating
against the dollar, euro and Japanese yen. A Chinese currency that
becomes a regional currency would validate and facilitate China's
emergence as a global economic power and reduce dependence on the
dollar. It would also make possible renminbi financing throughout the
region. Chinese official data show illicit capital inflows in 2002
instead of the usual drain, indicating new confidence in the Chinese
currency.

Japan's latent banking and debt crisis makes the yen less suitable as a
vehicle for wider Asian monetary integration, some experts believe. In
turn, the mighty dollar could become relatively less important in an
area dominated by trade links with China. So argue George von
Furstenberg and Jianjun Wei of Indiana University, in a recent academic
paper proposing that a fourth major international currency, after the
dollar, euro and yen, will have to crystallize in continental East Asia.
"If and when China's currency . . . develops into a major international
denomination rivalling the yen, it could become one of the two pillars
of a multilateral monetary union with most other East Asian (and some
Southeast Asian) countries," they write.

Long-term trends lend support to this view. There is the growing size
and importance of China's financial system, assuming sustained economic
growth, and the fact that the relative importance of the U.S. market to
China and Hong Kong is shrinking. "China is today a medium-sized economy
with GDP equivalent to that of Italy," writes Jonathan Woetzel, a
Shanghai-based director of consultants McKinsey & Co. in his new book
Capitalist China. "What makes it distinctive is its growth. By 2010, it
is expected to almost double in size to rival Germany. With continued
growth it will surpass Japan by 2020."

There are signs that East Asia's combined real GDP could even exceed
that of the United States if productivity growth and technology catch-up
continue at a rapid pace. "Based on this outlook," argue the paper's
authors, "we do not share the view that maintaining a U.S. dollar peg,
particularly with the yen-dollar rate on the loose, would continue to
bring the blessings of stability to a continental East Asian monetary
area far into the future."

That's not to say the renminbi will emerge as the dominant Asian
currency in the near future. After all, Japan tried and failed to build
a yen-trading bloc in Asia at the height of its boom. But the needs of
hungry Japanese corporations overseas meant that Japan's banks went on a
lending spree that contributed to the weakening of the yen. And some
analysts see an interim period during which China will rely more heavily
on the dollar as it pulls in foreign direct investment, bolsters its
reserves and stretches its trading wings farther afield.

For now, and perhaps the next few years, there are clear limits to the
scope of the renminbi. The overwhelming majority of foreign-exchange
transactions in the world involve the trading of shares, bonds and other
financial instruments. Actual transactions involving goods and services
amount to probably less than 10%. China's currency won't figure in
financial-service transactions until full convertibility.

Even if 30 billion renminbi is circulating outside China, that's barely
2% of the total value of the currency in circulation. The dollar will
likely continue to dominate the region because the U.S. is a net
borrower. "The reason the yen and the euro are not as strong as the U.S.
dollar is because both Japan and the European Union are net lenders, not
net borrowers," says Freris of BNP Paribas. China is also a net lender
with a total estimated foreign debt of $170 billion against its reserves
of $300 billion--much of this denominated in U.S. treasuries.

While its spread across Asia presages a wider role, the renminbi's
strength against the dollar and yen are far from assured. China may have
another economic downturn, or a banking crisis that would puncture
confidence. The renminbi also needs to secure legitimacy in the free,
open market, rather than in shadowy corners of Southeast Asia's marginal
economy. As Zeng of Sparkice points out: "It is only when China has
surpassed Japan economically and Japan is bogged down in stagnation that
the renminbi can acquire the position as a common currency in Asia."

Susan V. Lawrence in Beijing contributed to this article