by Michael Pettis
My central bank seminar at PKU had a fascinating discussion this week about the internationalization of the RMB in trade transactions. To summarize, although the amount of trade denominated in RMB is still small, it is growing at a very rapid pace. This is often given as very strong evidence that the RMB is on its way to becoming a major, if not the dominant, currency in international trade. My ever-skeptical students, however, were not wholly convinced.They pointed out that according to PBoC data on external RMB transactions, if you exclude the services component (which they believe consists mostly of remittances), 93% of the trade transactions denominated in RMB consist of Chinese imports while only 7% consist of exports. They argued that in fact export-denominated transactions are even smaller if you exclude intercompany exports, which dominate the export numbers but not the import numbers.
When a Chinese exporter sells something to its offshore affiliate, in other words, which is then sold on to the end buyer, a foreigner, the offshore affiliate denominates the sale to the end buyer in dollars while it denominates the purchase from the onshore affiliate in RMB. In that case it is not meaningful to say that the trade took place in RMB rather than dollars, although it does show up on the PBoC books as a foreign trade transaction denominated in RMB.
So why the huge imbalance between exports and imports? If transacting in RMB were genuinely more convenient for exporters and importers, you would probably see a much more balanced split. In fact since China exports more than it imports, you could even argue that exports denominated in RMB should exceed imports.
But that isn’t the case. One possible explanation is that denominating trade in RMB is convenient only for Chinese companies, not for foreign companies. In a world of deficient demand, it is buyers who have the power to dictate terms, not sellers, so in that case Chinese buyers (importers) can force foreigners to trade in RMB while Chinese sellers (exporters) cannot. This seems plausible to me, although as one student pointed out, it suggests that there is a limit to the amount of trade that is likely to be denominated in RMB – the size of China’s imports.
But it still seems like a huge imbalance, which brings in the other explanation. As the students making the presentation pointed out, the mechanics of the trade transaction denominated in RMB requires that foreign buyers must either buy RMB or borrow RMB in Hong Kong in order to pay for Chinese exports. On the other hand foreign sellers are long RMB in Hong Kong once they conclude the sale to the Chinese importer.
With so many foreign sellers ending up with long RMB positions and so few foreign buyers ending up with short RMB positions, it should be very easy for the buyers to close their shorts in the Hong Kong RMB market. But that isn’t the case. In fact it is very hard for them to buy RMB. In spite of the disproportionate amount of long positions versus short positions, no one seems to want to sell enough RMB to the shorts.
Why would that be? Most probably it is because the sellers want to take speculative long positions in the RMB, perhaps because they expect the RMB to appreciate. Is this truly what speculators believe? Yes, and we have corroborating evidence – there is a lot of demand for RMB-denominated assets and very little supply, and most proxies for hot money inflows suggest that the hot money demand is strong.
So what did the seminar participants conclude? They claim that what is driving the increase in the RMB-denominated trade is probably not any preference to transact in RMB but rather speculative demand for RMB. That sounds pretty plausible.
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