As the Chinese currency continues to perform strongly against the dollar, large corporates trading into and out of China are reportedly looking to ramp up their use of yuan-denominated trade finance products. Yet concerns remain over the potential impact a burgeoning Chinese currency could have on smaller domestic exporters.
The renminbi (Rmb) has risen markedly since the early months of last year. At that time, the Chinese currency fell to its weakest point against the greenback since 2008 as concerns over the spread of Covid-19 led to lockdown restrictions in provinces across the country.
The currency plunged to 7.16 against the US dollar in May, and stood at 6.86 in January last year. The latest recorded data from the Bank of England shows that the spot exchange rate was registered at 6.46 through Tuesday this week.
Rajiv Biswas, Asia Pacific chief economist at IHS Markit, points to the depreciating US dollar, China’s strong economic performance in the face of Covid-19 last year, and export growth in the second half of 2020, as reasons for the Rmb gaining ground.
The Chinese economy rebounded quickly after a historic contraction in Q1 2020, which saw it pummeled by Covid-19 containment measures and the new year holiday in the early months of the year.
While other major nations saw their economies fall into negative territory, China registered a positive annual growth in GDP of 2.3% in 2020.
This was partly driven by a surge in exports, with Chinese customs data showing export growth of 21% year-on-year in November, dropping only slightly to 18% in December.
Meanwhile, the dollar, which this month fell to its lowest level since April 2018, lost almost 7% of its value against a basket of other major currencies last year – all of which has helped spur on the Rmb.
Against this backdrop, there are signs that opportunities are emerging for companies trading into and out of China on the trade finance front, and that corporates are increasingly considering yuan-denominated products rather than the traditional and dominant currency for trade, the greenback.
According to Sriram Muthukrishnan, group head of trade product management at DBS Bank, there has been a pick-up in enquiries from corporates on how to take advantage of the strengthening Rmb for trade into and out of China.
He tells GTR that this surge in interest over the last few months has come from larger commodities customers particularly those in the metals and mining space, as well as in the soybean sector.
Muthukrishnan notes that because US dollar discounting rates are currently low – the short tenor US dollar Libor being “close to zero” – firms in China are able to obtain a letter of credit in yuan and then discount it offshore in dollars. Even with the hedging cost of switching back to the dollar, this is still currently cheaper than getting a loan onshore in China, he says.
“It is still possible to structure the deal so that it is well short of the 3.5% to 4% that they would pay for getting a loan in China onshore,” Muthukrishnan adds.
Rmb squeeze for SMEs?
While larger corporates may benefit from further appreciation of the Rmb, particularly in the commodities sector, concerns linger over the potential effects of an emboldened Chinese currency on SME exporters.
As of yet, Chinese exports as a whole have not been dented by the appreciation of the Rmb, defying the logic that a stronger currency hampers domestic exporters.
Biswas at IHS notes that China’s manufacturing exports have grown at a “rapid pace” in recent months and that key manufacturing export segments have performed well.
Pointing to personal protective equipment (PPE) and high-value added electronics, he notes that they have “benefited from strong global demand growth due to pandemic-related factors, outweighing the impact of yuan appreciation”.
Other manufacturing export sectors are less likely to see those benefits, however.
“Low-cost segments such as low valued-added garments and electrical products face more severe competitive challenges from other low-cost competitors such as Vietnam and Cambodia, as yuan appreciation has eroded the competitive advantage for Chinese production,” Biswas says.
SME exporters in particular face narrowing profit margins and will likely require low-cost financing to remain solvent, he adds.
Muthukrishnan agrees that SME exporters, especially those not part of larger supply chain ecosystems, could be squeezed if the currency continues to appreciate.
“If they’re focused on exports, but the goods are sourced locally and the cost of production is denominated in Rmb, they will find that they are losing orders when they try to sell overseas,” he suggests.
Shirley Kwong, HSBC’s head of sales for global trade and receivables finance in Hong Kong, says many SME exporters will already have measures in place to address that issue, however, adding that the bank “expects to see a growing need for Rmb hedging products this year”.
According to Kwong, Chinese exporters have historically used various different measures to hedge currency changes, “such as establishing production sites in other locations in Asia, receiving Rmb instead of US dollar from buyers, and opting for cross-border financing”.
Longer-term Rmb trends
Some economists, including Biswas, suggest that the gradual appreciation of the Rmb in 2021 could be supported by a number of factors, including continued growth in the economy and manufacturing exports.
Demand for Chinese goods globally looks likely to continue in the near term, on the back of strong export figures in the past few months. Meanwhile, a report released by ABN Amro last week forecasts China’s GDP to grow by 8.5% this year.
Nevertheless, Beijing has a history of stepping in and curbing what it sees as excessive appreciation, which could well curtail a sustained rise this year.
One tactic the Chinese government has turned to is the buying up of cash flowing into the country, and just last month Reuters reported that major state-owned banks were swapping dollars for yuan in an effort to keep the currency in check.
The Chinese government has also taken steps to internationalise its domestic currency, reducing its reliance on the US dollar to facilitate cross-border trade.
A report released by the People’s Bank of China last year on the internationalisation of the Rmb shows that cross-border Rmb settlements for the trade of goods internationally rose by 16% in 2019, and that the currency accounted for 13.4% of total cross-border settlements for goods.
According to Muthukrishnan, there is a longer-term trend towards the use of the Rmb in Asia trade specifically.
“The Rmb has been featuring more prominently as a leading currency for trade finance in recent years, especially in Asia, and would be an interesting space to watch. It overtook the greenback as the most used currency in the Greater Bay Area, with transactions worth US$2.65tn cleared last year,” he says.