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Challenges and Opportunities of the internationalisation of the RMB: An interview with Ernst Theodor, LBB-INVEST

13 January 2017
Giada Vercelli

The success in making the RMB more widely used has also allowed offshore players to sell short on the Chinese currency. Last week the RMB in Hong Kong ran at a stronger pace against the USD than its mainland equivalent, a key development that could support the Chinese government’s effort to slow down capital outflows from the mainland. Since the surprise devaluation in August 2015, a weaker rate for the currency in markets outside China has been the norm – hence the strong capital outflows. Volatility in the internationalisation process of the RMB comes just when the pressure of structural rebalancing on China’s domestic economy is also intensifying.

Ernst Theodor Kirschner, Fund Manager, LBB-INVEST discusses the challenges and opportunities created by the RMB internationalisation process with Giada Vercelli, ahead of this week’s Central and Eastern European Forum 2017 in Vienna.

Giada Vercelli: How worrying is China’s economic slowdown and currency volatility given the FX circumstances?
Ernst Theodor: From a Euro investor point of view there is not much volatility in the RMB. We are still confident that the government is able to control the slowdown enough to avoid a hard landing. The recent increase in yield and weakness in the currency makes it an attractive investment in the local currency space.
GV: We have seen two, almost three, bubbles forming and bursting (property, stock market, credit). What is the impact on trust in the Chinese investment offer?
ET: We have all seen these booms and busts but as a foreign bond investor you were not really a part of it. Maybe they weren’t handled in the best manner but in the end the authorities got it under control. The only impact on our investment in China is that we tend to avoid tier 2 and tier 3 property developers.
GV: The RMB has appreciated in 2015, but depreciated in 2016 against the CFETS basket, which measures the USD versus other major currencies. However, the Chinese central bank has enjoyed a certain degree of flexibility in its currency policy action by referring to different indices – CFETS and SDR – to gauge RMB stability. What does this tell us about China being ready to plug into the international capital markets? And if so, what can be done to achieve more transparency?
ET: The best solution in our view would be to open the bond market for foreign investors to make it eligible for the big indices. The resulting flow could even lead to appreciation pressure in the currency. We do not understand the fear of the authorities on this aspect. Are they afraid of us buying their government bonds?
GV: As the Fed raises rates, the USD is expected to keep on strengthening, and the RMB to depreciate. Can we expect a new wave of capital outflow from China?
ET: Capital outflow is already happening and it seems like it is happening in very creative ways due to the official capital controls. But as I said before, to create external demand for the currency to offset the outflow, an inclusion in the big bond indices would be a pretty easy way to go.
GV: Are you under the impression that RMB internationalisation is still a high priority for China or not? Is 2017 going to be the year of RMB renationalisation?
ET: It is definitely still a high priority for the authorities. They made strong efforts to make us believe that they want to have a reserve currency. Thus the currency should be (relatively) free to trade and hard. In order to achieve this with the current outflow problems, it might take cautious steps to open the market but the big picture is not blurred by this.
GV: Has the role of RMB internationalisation as a force to push through financial deregulation been largely completed?
ET: No, there are many steps to go.
GV: What does the RMB’s inclusion into IMF’s SDR basket mean for asset allocation and ALM strategies?
ET: If the RMB really achieves some kind of reserve status and I mean not just on paper (SDR inclusion), it should become a major funding currency. Especially given the fact that many assets are in the Chinese currency space, the liabilities could be better managed to match them.
GV: What are the overall benefits for the CEE of RMB inclusion in the SDR basket?
ET: It is another large currency market to tap into for funding. Local currency investors like the diversification of having non-Asian issuers in this market and thus there is demand.
GV: The analysis on capital flows between China and the rest of the world based on interest rate differentials is somewhat flawed, because China does not have an open capital account (i.e. free flow of capital). How will the Chinese slowdown impact the internationalisation of the RMB and capital account opening?
ET: It will probably slow the process down but we don’t think that it has serious big picture consequences. A one step big bang solution is not viable at the moment given the outflow problems.
GV: Without significant capital outflows, would the RMB even appreciate, because China runs the world’s largest trade surplus which underpins the RMB?
ET: Yes and we think that with capital account opening the outflow could be offset by the inflow of foreign money due to index inclusion.
GV: Trust is a key factor in getting China up to the correct standards. What are the challenges for the RMB to become a credible rival to the USD?
ET: Spread of use. Not all banks are set up to trade the currency. Some are even shutting down the desks due to lack of business.                                                                                                                                                                                                                                     
GV: Does the RMB have the potential to become a commodity pricing currency?

ET: As one of the largest consumers of commodities it should be a possibility in the long term.
GV: What is the RMB’s role as a trade, investment and reserve currency?
ET: To be seen but as the US under Trump might not be the patron of free trade anymore, China might step in. Especially for countries which might face problems with the new US administration such as Iran and Mexico this might be a chance for China to spread its influence, and with that the use of its currency.
GV: If demographics are important for the specific weight of a currency, what can we make of the INR? Today it is heavily regulated, but can we expect it to provide competition for the RMB?
ET: For INR the bottleneck was, and unfortunately still is, regulation. We have been trying to open a local account for three years now. In these three years, the law changed twice cancelling the whole process and requiring a restart of the application. I am still young and hope to see the account set up and running one day but it is a frustrating experience. And we do not understand the fear of the Indian government. Are they afraid of us buying their government bonds?
GV: Holding debt has been proven to be a weapon: last year Saudi Arabia threatened to flood the market with USD750bn of US government debt. What does this tell us of China as an investor of last resort?
ET: That “may you live in interesting times” might be a curse well suited for my generation. There are many “interesting” potential conflicts between the US under Trump and China moving in an increasingly more nationalist direction. Ranging from Taiwan, Senkaku Islands and the South China Sea as geostrategic to the threat of a trade war, there are many things that could go wrong.
GV: China also benefits from more organic and centralised policies than the West, given its political profile, structure and organisation. Can the development of the capital markets benefit from this centralised approach?
ET: Development of the capital markets could benefit from the centralised approach as quick and decisive measures are possible for the administration. But it cuts in both ways. So a mood change can have vast consequences.
GV: What is a realistic time frame for China to get up to speed with the international capital markets?
ET: As I said above, this depends completely on the mood and willingness of the administration and is therefore hard to predict.
GV: As Chinese banks are too heavily involved in domestic risk, what can be done to spread risk?
ET: The degree of centralisation is still too high. When speaking to people working at the German branch of Chinese banks, all you hear about the decision making process is, “we do what the main office in China tells us to do”. This is not a modus operandi to spread risk.

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