Why the Bundesbank is a reluctant Rmb investor

German central bank will include the renminbi in its currency reserves but meanwhile slams China for interfering in markets. The move showcases institutional investors' struggle to deal with China’s growing influence.

Deutsche Bundesbank’s Andreas Dombret said on Monday that China needs to dismantle its system of currency controls and win the trust of foreign investors before the renminbi can become a more widely used currency.

In the same breath, the German central banker announced the Bundesbank had decided to include the renminbi in its currency reserves. The move appears to have been taken reluctantly given his opinions on China’s currency policy making.

“The frequent and somewhat difficult to predict changes in regulation and the perceived high degree of political interference in the renminbi price formation – all of that places a burden on the trust of foreign investors in the system,” said Dombret, a member of the central bank’s executive board.

The Bundesbank looks to be taking a long-term view. Of the foreign-exchange reserves held by the world’s governments, just 1.1% are in yuan, compared with 64% for the dollar. However many analysts expect the renminbi, also known as the yuan, to appreciate in lock-step with China’s growing economic clout and its trade policy, dubbed the Belt and Road Initiative.

Dombret appears to be attempting to make the most of the central bank’s investment.

“For a more widespread use of the renminbi these burden factors actually need to be reduced,” said Dombret at the Asian Financial Forum (AFF) in Hong Kong on Monday.

Markets looked through his words to the Bundesbank’s actions and the renminbi rose to its highest level in 25 months.

The renminbi has taken on a more important role in financial markets. On October 1, 2016 the renminbi joined the International Monetary Fund’s (IMF) special drawing rights (SDR), a global reserve that previously only included the dollar, euro, yen and pound. 

Germany already has a bilateral currency swap agreement with its counterpart in China, the People's Bank of China (PBoC), a renminbi clearing house in Frankfurt.

“The internationalisation of the renminbi is characterised by gradualism. It proceeds in a multitude of small steps, but some of those small steps include a few steps back,” said Dombret who has been a member of the executive board of the Bundesbank since May 2010 with responsibility for several areas including banking and financial supervision.

“More recently the renminbi internationalisation process seems to have lost a little bit of momentum. A series of measures to restrict capital outflows from China have been imposed over the recent one and a half years,” said Dombret, who is also the Bundesbank’s deputy at the IMF.

The renminbi plunged around 6.5% in 2016, due to tighter management of capital outflows and broad weakness in the greenback. In Hong Kong, the largest offshore market, yuan deposits have plunged by 47% from their peak in December 2014.

“This may have been mostly triggered by capital outflows from China in 2015 and but also in 2016, and by the ensuing sale of $1 trillion of foreign reserves by the PBoC,” said Dombret.
The central banker sought to explain at the forum, which is attended by Chinese government officials, why foreign investors are worried about holding renminbi.

“The exchange rate regime of the renminbi lacks somewhat transparency. Some observers, also from Europe, have the impression that it is dominated by discreet policy interventions by China,” said Dombret.

“One possible factor for this impression is the introduction of an anti-cyclical factor in the fixing mechanisms in May, 2017 – however recent use suggests the factor has been abandoned altogether – something which we would welcome very much,” said Dombret.

The PBoC earlier in January reduced the influence of the “counter-cyclical factor” in the formula it uses each day to determine the mid-point reference rate against the US dollar.

Introduced in May last year, the "counter-cyclical factor" helped push the renminbi to 6.5 to the dollar.

Andreas Dombret

The importance of the counter-cyclical factor is underlined by looking at when the renminbi appreciated most last year. When the new factor was added to the formula on May 26, the renminbi stood at 6.8555 to the dollar; by the end of the year it was 6.5067 to the dollar, an appreciation of 5.1% – some 84% of the full year's 6.1% appreciation.

Dombret didn’t hammer China’s currency policy from all angles. He disputed claims that China has devalued its currency to help its exporters. 

US President Donald Trump’s election campaign promise that if elected he would name China a "currency manipulator" for artificially depressing the value of the yuan to make its exports more competitive.

“According to our estimates the value of the renminbi does not provide Chinese exporters with a competitive advantage,” said Dombret.

“On the contrary, price competitiveness of the Chinese economy is estimated to be rather low. So from this perspective accusations of an undervalued renminbi, they are actually not warranted,” said Dombret.

However, he returned to his theme that China needs to reduce controls, for example corporates registered in China cannot buy or sell foreign currency offshore, unless they obtain prior approval from the relevant authorities, before the renminbi can spread further. 

“The renminbi needs to become much more flexible and to be much more convertible and existing capital controls need to be dismantled substantially in order to achieve this goal,” said Dombret.

The renminbi may well be given a fillip by China’s trade policies if private investors are confident enough to participate. China’s Belt and Road venture might still be funded largely in dollars but the sheer number of infrastructure projects are likely to provide greater opportunities for the renminbi once new trade, industrial and transportation links are created.

The renminbi is set to become a more acceptable means of payments in many emerging markets. Pakistan only recently rejected a Chinese proposal to make the renminbi legal tender in Gwadar, Balochistan, where Pakistan has a free trade zone.

According to data from China’s State Information Centre, in 2016, total international trade of the 64 Belt and Road countries amounted to $7.2 trillion, accounting for 21.7% of global trade.

Since the launch of the initiative in 2013, Beijing has signed currency swap agreements with 33 countries and territories including financial hubs such as Hong Kong, Singapore, London and Sydney.

“As we continue to see the Belt and Road develop, as we continue to see green finance develop, a lot of this will be done in renminbi and this will increase the usage of renminbi even further as we go along,” said Stuart Gulliver, outgoing group chief executive of HSBC Holdings, who was also speaking at the AFF.

Others at the forum urged China to act responsibly and with tact given its growing influence. 

Policies that other trading nations tolerated when China was a $1 trillion annual GDP country are now unacceptable given it is a $12 trillion juggernaut said David Lipton, first deputy managing director of the International Monetary Fund at the AFF.

“China’s credibility depends upon participating in a system that the rest of the world will support,” said Lipton. “It is in China’s own interest – how can China act in a way that will make open system last,” he added.

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