Cablegate: China/Rmb Internationalization: Some

DE RUEHBJ #0350/01 0410753
R 100753Z FEB 10 ZDS


C O R R E C T E D C O P Y - (PAR 1 AND 2)



E.O. 12958: N/A
SUBJECT: China/RMB Internationalization: Some
Progress, But Going Slow

REF: A) 09 Beijing 01176 B) Beijing 00147 C) 09
Guangzhou 000397 D) Shanghai 00015 E) NYFED Internal
FR 10/19/09 E) 09 HK 708, 1104, 1280, 1667

BEIJING 00000350 001.3 OF 004

1. (SBU) Summary. Hong-Kong-based HSBC bank last
week announced it had issued the first Renminbi-denominated
letter of credit in which none of the trading parties involved came
from mainland China. The move was the latest step
towards Beijing's stated goal of establishing the
Renminbi (RMB) as an internationally-accepted
currency for financial and trade settlements and,
eventually, achieving global reserve status. Over
the last three years, China has implemented a series
of programs to increase international use of the RMB,
although as yet these initiatives are still
extremely limited and under-utilized. The tentative
nature of China's moves has inspired some
commentators to question Beijing's commitment to
undertake the systemic foreign exchange and
financial system reforms necessary to make the RMB
an attractive or practical international currency.
Although many senior Chinese officials believe the
Renminbi eventually should become a key
international currency, commensurate with the
country's status as the world's (soon-to-be) second
largest economy and largest goods exporter, this
conviction is far from universal. Virtually all
observers expect the PRC Government to move
gradually and carefully toward internationalization
of the RMB, but most expect the process to take many
years. End Summary.

First (Baby) Steps

2. (U) On February 3, HSBC Malaysia issued the first
RMB-denominated letter of credit involving both a
bank, importers, and exporters all outside of mainland China.
Last week's groundbreaking transaction followed
HSBC's similarly novel transactions in 2009, when it
became the first foreign bank to execute a RMB trade
settlement in Malaysia. Subsequently, the firm
conducted similar arrangements in Hong Kong, Brunei,
Indonesia, Singapore, Thailand, the Philippines and
Vietnam, all in partnership with the Mainland's Bank
of Communications (BoCom).

3. (SBU) HSBC's moves were possible because of the
Chinese government's announced policy to increase
the use of the RMB in international transactions,
with the stated goal of making the RMB an
international reserve currency. In this vein, over
the last several years Beijing has approved several
reforms and pilot programs aimed at increasing the
number of RMB-denominated financial tools and
providing RMB to a few actors to use in
international settlements. For example, in 2007
Beijing began allowing a few select Mainland (and
later Hong Kong) banks to issue RMB-denominated
"panda" bonds in order to both allow institutions to
raise money in RMB and to provide some tradable RMB
financial tools. In late-2008 and early-2009,
Beijing signed currency swap agreements worth USD
124 billion with Malaysia, South Korea, Belarus,
Indonesia, Argentina, and Hong Kong. In theory
these swaps could allow central banks to hold RMB,
and could push RMB out of China should traders wish
to settle their transactions in PRC currency.

4. (SBU) Under a pilot program begun in July 2009, a
select group of 400 Chinese companies were allowed
to price their exports in RMB. Transactions were
permitted to take place through accounts established
in Hong Kong and five selected mainland cities
(Shanghai, Shenzhen, Guangzhou, Zhuhai and Dongguan).
Another pilot project covers trade between the ten
Association of Southeast Nations (ASEAN) member
countries and Yunnan and Guangxi Provinces. These
trade settlement programs were intended to increase
the presence of RMB in the Hong Kong banking system
by up to USD 70 billion in the first year, and also
to create demand for more RMB-denominated financial
products. Providing more of those financial
products, the first Chinese government bond sale
outside the mainland occurred in Hong Kong in

BEIJING 00000350 002.2 OF 004

September 2009, when China's Ministry of Finance
officially launched the sale of RMB 6 billion (USD
879 million) worth of sovereign bonds.

Limited Progress

5. (SBU) China's initial efforts at RMB
internationalization have not been an unmitigated
success. The Chinese currency is still rarely used
in global foreign exchange markets and almost no
global foreign exchange reserves are held in RMB,
primarily because the currency is only partially
convertible. Thus far there has been less usage of
the RMB-denominated trade settlement agreements and
interest in the bond issues than was expected (REF

6. (SBU) A Chinese economist explained to Econoffs
that the amounts involved in the trade settlement
agreements and bond issues were "miniscule" compared
to overall trade numbers and the size of the Hong
Kong capital market. A Hong Kong-based HSBC analyst
agreed that the "take-up has been very low" and that
there was a "high degree of stage management" at the
launch of a trade settlement pilot project in Hong
Kong earlier this year. He claimed that some of the
corporations listed in the scheme were not in fact
participating, and other corporate executives
admitted that they were participating purely for
political reasons and had no business interest in
the project. Banking contacts have explained that
foreign traders are reluctant to denominate in RMB
since they cannot hedge their currency risk (due to
the lack of a liquid, transparent market for Chinese
RMB forwards or exchange rate swaps) and the system
is still not user-friendly (REF D).

7. (SBU) Regarding the bilateral swap agreement,
hailed by Beijing as a step toward ensuring greater
use of the RMB in international commerce, Embassy
contacts generally dismissed the swaps as "mostly
window dressing." A Chinese banker said the swaps
were set up to show Asian countries that the RMB
could be a regional currency. But a local Chinese
economist working for a foreign bank told Econoffs
that the swaps did little to advance RMB
internationalization, adding that they were designed
to operate more like an emergency credit line and
"in fact were not used extensively."

Questioning Beijing's Intentions

8. (SBU) Beijing's slow pace in implementing the
reforms necessary for RMB internationalization has
led to criticisms that the government is not serious
about the goal of establishing the RMB as an
international reserve currency. The HSBC analyst
explained that Beijing is "playing a cute game,"
positing that if China had really wanted to
internationalize the currency it could have done so
by now. Importantly, he opined that Beijing would
like to become more "globally relevant without
taking on any risks." Put another way, one Bank of
China economist said the difficulty centered on the
fact that China wanted to promote full
convertibility, but also wanted stability, so full
internationalization was "not yet possible." The
local Chinese economist working for a foreign bank
was less critical, noting that "they have to start
somewhere." She argued that while, at the moment,
the rules on trade settlement and bond issuance were
very strict, Beijing was working to loosen them,
which would increase participation.

9. (SBU) In part, the Chinese go-slow approach to
RMB internationalization reflects Beijing's
preference to proceed cautiously when it comes to
any major financial reforms. However, it also
represents an on-going debate among policymakers on
the wisdom of moving forward quickly towards full
use of the RMB in international transactions.


BEIJING 00000350 003.3 OF 004


10. (SBU) Some of those pressing most strongly for a
greater role for the RMB are concerned about hedging
dollar risk. Former PBOC Vice Governor Wu Xiaoling
said at the annual Caijing magazine conference on
December 18, 2009 that the RMB should play a role in
building a multi-reserve currency system to cushion
U.S. dollar fluctuation risk. The recent rapid
growth of the U.S. fiscal deficit has -- regardless
of the reality -- reduced Beijing's confidence in
the stability of the dollar and the value of dollar-
denominated assets, which are estimated to
constitute about two-thirds of China's USD 2.4
trillion of foreign exchange reserves. The Chinese
economist told Econoff that "one of the main motives
behind the [RMB internationalization] initiative is
the weakening dollar, which is under threat from
structural problems in the United States." She
explained that by conducting trade using RMB, China
would hope to reduce dollar and foreign exchange
accumulation. RMB-denominated trading, the argument
continues, also would somewhat insulate Chinese
exporters from foreign currency volatility.
(Comment: These arguments are somewhat specious from
an economic standpoint. In many cases the popular
arguments for RMB internationalization belie a
limited understanding of the economics underpinning
the process. China will continue to acquire foreign
reserves as long as it runs a large surplus, and
exporters will still always assume foreign currency
risk in terms of fluctuating prices if not
fluctuating exchange rates. Comment.)

11. (SBU) Beyond these relatively direct, if not
entirely practical, considerations, other supporters
of RMB internationalization are clearly looking for
"soft power" gains in political, economic, and
financial global fora. This view is widespread in
China: as Chairman Li Jiange of China International
Capital Corporation (CICC), a major Chinese
investment bank, recently asserted in a public
speech: "I believe it is a historical responsibility
for China to have a bigger voice globally." Former
Hong Kong Monetary Authority CE Joseph Yam and
current PBOC advisor has called for the RMB to
become a "third pillar" of the global monetary
system. Speaking privately, senior Chinese
officials have noted that the RMB could become a
component of the IMF's Special Drawing Rights Basket,
but for symbolic, political reasons rather than a
practical reflection of the RMB's
internationalization (REF A). The position that the
Chinese currency eventually should become a key
international currency, commensurate with China's
rapidly expanding political and economic clout is
widely popular, and frequently supported by popular
commentators and netizens.

12. (SBU) Still another group advocating RMB
internationalization hopes to leverage this popular
support for RMB internationalization into larger
(and less-popular) financial and foreign exchange
reforms. The managing director of a major Chinese
investment bank said that RMB internationalization
would serve China, because reformers could use it to
further economic reform. He claimed every decade
needs a popular objective to drive reform: in the
70s, it was land reform; in the 80s, opening to
foreign investment; in the 90s, preparation for WTO
accession; now, RMB could play this role. Likewise,
a well-known Chinese pundit at the Chinese Academy
of Social Sciences (CASS) has actively promoted RMB
internationalization, because in order to achieve
such global status China must fundamentally reform
its foreign exchange and financial systems.

Verses the Go-Slow Club

13. (SBU) In fact, one of the major reasons for the
slow pace of RMB internationalization is the need
for -- and opposition to -- such systemic reforms
(see REF E for a full explanation of the required
changes). Beijing has made no secret of its desire

BEIJING 00000350 004.2 OF 004

to proceed deliberately. Premier Wen Jiabao said at
the September 2009 World Economic Forum in Dalian,
China that China had made "progress in the RMB's
internationalization, yet it would take quite some
time before the RMB truly became an international
currency." Likewise, Li Yang of Chinese Academy of
Social Sciences (CASS) told Econoffs that the RMB
internationalization process would be very long,
with the government's steps of the past year (e.g.
use of RMB for cross-border settlement, currency
swaps) just the start.

14. (SBU) The requirement for a more flexible
exchange rate system, and thus significant exchange
rate appreciation, faces significant opposition.
The RMB effectively has been pegged to the U.S.
dollar for the past year and a half; resumption of
the appreciation, either through a one-off
adjustment or use of a more flexible exchange rate
mechanism, would be opposed by various power bases
in China, including most of the economic ministries,
provincial and local governments, and export
industries fearful of losing price competitiveness
due to currency appreciation (REF B).

15. (SBU) Further, for the RMB to become truly
international China also would need to open and
develop its capital markets. Not only would this
imply a significant loss of government control over
the economy, but without a flexible exchange rate
regime it could generate capital flows that would
likely disrupt domestic financial conditions and
hinder the PBOC's ability to conduct monetary policy.
In recent times, China has been able to intervene
and address this problem through sterilization, at a
large and rising cost. In the future, when those
costs would eventually become prohibitive the
central bank would be forced to choose between
currency appreciation and domestic inflation.
Underlying all of this is the fact that foreign
investors would not want RMB unless there were
financial products in which they could invest, and
traders settling transactions in RMB would want to
be able to hedge their foreign exchange risk.

So What is the Plan?

16. (SBU) Looking forward, the Chinese economist
asserted that "it is not clear that there is a
coherent strategy or even a coherent idea of what is
meant by internationalization." The CASS professor
agreed that, at the moment "there is no plan" for
RMB internationalization. There may be, however, an
informal "academic and governmental consensus" on
several possible alternatives for the future which
the government is pursuing simultaneously. A
foreign academic noted that even if China was not
sure yet what it wanted, "by simply bringing up
various ideas, China was setting up the global
agenda and debate."

17. (SBU) Without a plan, virtually all observers
expect the Chinese Government to move gradually and
carefully toward internationalization of the RMB. A
convertible RMB and flexible exchange rate would
come first, but not for perhaps 5-10 years. Open
capital markets would also take at least 10 years.
But some are even more conservative: when asked to
provide a time line for RMB internationalization,
the professor answered: "maybe in my lifetime" (he
is 61). In all likelihood, the sophisticated
financial market, improved infrastructure, adequate
supervision and transparency required for RMB
reserve status is decades in the future.


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