Joachim Nagel: The internationalisation of the renminbi - opportunities
for German industry
Speech by Dr Joachim Nagel, Member of the Executive Board of the Deutsche Bundesbank,
at "Bayerischer China-Tag", Ingolstadt, 19 October 2015.
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Ladies and gentlemen
Thank you very much for inviting me to the Bayerischer China-Tag.
Over the past few years, China has become a subject that has grown ever closer to my heart.
In saying that, I am not just thinking about the steadily closer ties between our countries. On
my trips to China, I have also constantly been noticing many things we have in common.
Germany is regarded in China - at least in my experience - as a very reliable partner and as
a model in many kinds of issues. In particular, the German economic model with a strong
Mittelstand and the financial sector's function of fundamentally serving the real economy are
cited as models in China.
Speaking about China at the moment, we often first think of headlines such as "Slump in growth
in China" or "Stock market crash in Shanghai". In my speech, I want to put those headlines
into perspective and set them in the context of China's ongoing opening - and, saying that, I
explicitly do not mean just its financial and economic opening, but rather the overall
transformation process in the Chinese economy. I shall give a brief overview of the status quo
and present the outlook for the future internationalisation of the renminbi and for what
opportunities this will open up not only for large German enterprises, but also - and especially
- for the small and medium-sized firms which are so important in Germany and well regarded
in China.
Following a long period of strong gains, stock prices fell dramatically in the summer of this
year, first in July and then again in August. As I see it, the significant slump in prices on the
Chinese stock market represents, first and foremost, a correction of the preceding rapid
increase. Between mid-2014 and June 2015, equity indices went up by around 150%. For
many market participants, this was a clear indication of an exaggeration. Yet again, it became
apparent that financial markets are not a one-way street - not even in China. Since the capital
market in China is still comparatively heavily regulated in comparison with other large
economies, the direct wealth effects of the slide in prices were limited for foreign investors.
That is because roughly only 3% of the equities are held by them.
The contagion effects stem from the far greater worries of investors about a slump in growth
in China and its repercussions for the global demand of the People's Republic. Nevertheless,
as I see it, the price slump was not driven solely by the poorer outlook for the Chinese
economy. Another key factor was speculation about when the United States would adjust its
ultra-accommodative monetary policy with the first interest rate hike since 2007. These two
topics were the subject of much discussion during the typically less busy trading days in
August. The absence of many market participants led to less liquid and more volatile markets.
These various factors can explain why the correction on the markets was so violent.
The Chinese government revised its growth forecast downwards compared with previous
years to what is now 7%.1 This is much lower than the larger growth rates of past years. Even
so, I would like to put this supposedly bad news into perspective: China is now the
secondlargest economy in the world. By virtue of its sheer size alone, this means that growth of 7%
today will leave a larger footprint on the global economy than, say, growth of 11% did in 2005.
In addition, more moderate rates of growth are a typical consequence of the catching-up
process of emerging market economies with rising per capita income. Just to make it absolutely
crystal clear what this supposedly small growth of 7% means in terms of size, it should be
considered that this is an increase which is roughly equivalent to the annual gross domestic
product of Switzerland.
The lower rates on the road to a more balanced path of growth are accompanied by a
departure, which was initiated some years ago, from a purely export-oriented economic model
to one that is more consumer-oriented. This transformation can also be seen in the sectoral
growth rates. The services sector, for example, now contributes a share of roughly 50% to
Chinese GDP. The government itself describes the lower overall rates of growth as the "new
normal".
The current slowdown in Chinese economic activity has left a clear mark on the international
financial markets recently. It is true that China's economy, which takes up some 10% of global
goods imports, is very important. But retarding effects on resurgent activity in Germany would
be something to be concerned about only if there were to be a dramatic slump in the Chinese
economy. According to our estimates, a 4%-points drop in growth in China would lower
German gross domestic product by roughly a quarter percentage. Such a slump is not be
expected at present, however. All things considered, the neighbouring Asian countries - owing
to their geographical proximity and strong economic links - are likely to feel the negative effects
more severely than the western industrial nations.
We are seeing a clear correction in the industrial sector, in which excess capacity is being
reduced. This is also confirmed by German exporters and producers on site. Growth in trade
and services still seems to be good, however. Retail sales are clearly increasing and many
"New Economy" firms are rushing towards ever new records in sales and profits. Consumer
demand still appears to be intact. Risks exist on account of high levels of debt in local
government and state-owned enterprises.
Many observers still rate the data quality of cyclical indicators as a challenge. For example,
there are numerous monthly indicators for the industrial sector, but reliable data on the services
sector are often available only on a quarterly basis. China is now tackling this problem. At the
beginning of September, the National Bureau of Statistics announced that it would calculate
gross domestic product in future in accordance with international standards.
The Chinese currency, the renminbi, is playing a key role in the economic and political
transformation. In the export-oriented growth model it was an important management tool, but
its significance as an actively used instrument is waning given advancing transformation and
stronger orientation to services.
The internationalisation of the renminbi has come a long way over the past few years. The
renminbi has now becomes established as a trading currency. According to data supplied by
the international payment service provider SWIFT, in August the renminbi overtook the
Japanese yen among the most traded currencies. Although cross-border payments are
currently well below the use of the US dollar or the euro, its share of now 2.8% is remarkable.
As recently as 2012, it ranked in twelfth place with a share of merely 0.8%. This constantly
increasing use of the renminbi as a transaction currency is also the outcome of the worldwide
expansion in clearing houses. One example of this is the launch of the clearing bank in
Frankfurt am Main last year.
The renminbi has thus already taken its first step to being a trading currency. The next step to
becoming an investment currency is still being hampered by a number of capital controls. But
the barriers are constantly being dismantled. So far, the Chinese side has been acting very
prudently in these matters and I assume that will remain the case in the future.
The barriers are being dismantled by the constant expansion of existing programmes to
promote cross-border renminbi transactions. This is where programmes with investment
quotas for institutional investors are playing a key role. Furthermore, the merger of the
Shanghai and Hong Kong stock exchanges allow foreign investors limited access to the capital
market of the mainland.
Investors are increasingly using the renminbi as an investment currency. Also establishing the
renminbi as a reserve currency has been the declared aim of the Chinese government since
as long ago as 2009. China's interest in the renminbi being included in the basket of currencies
for the special drawing rights (SDRs) of the IMF is therefore understandable. It is also clear
that the currency basket should reflect the world economic balance of power. And, in that
respect, China has now undoubtedly become an economic heavyweight.
At present, the currency basket is based on the US dollar, the euro, the Japanese yen and the
pound sterling. For a currency to be accepted into the SDR basket, it must be significant for
international trade, serve as an internationally widespread medium of payment and be freely
usable. Inclusion in the SDR basket is currently reviewed at regular intervals in accordance
with the existing criteria. The outcome of the evaluation and the relevant decision are expected
before the end of this year.
Many commentators acknowledge the country's liberalisation efforts. The availability of
market-based exchange rates and interest rates is essential so that the currency basket can
go on fulfilling its intended purpose.
Furthermore, the Chinese central bank announced on 11 August 2015 that the daily fixing of
the exchange rate against the US dollar would be more closely geared to the price on the
previous evening. The renminbi subsequently depreciated markedly and can now fluctuate
more freely. Some voices in the media interpreted this as yet another deliberate attempt to
manipulate the exchange rate with the aim of inducing an artificial devaluation. As they see it,
China is supporting its own exporters by artificially boosting competitiveness. However, it is
also a further liberalising step by the Chinese government. Even the IMF has praised the move,
as this reform of the exchange rate fixing procedure gives greater weight to market forces.
The use of the renminbi is forging ahead in other areas of the capital market as well. For
example, "Dim Sum bonds" are now being issued across the globe. Named after the tasty
dumplings, these are renminbi-denominated bonds issued outside mainland China. Such
bonds issued in Germany have been dubbed "Goethe bonds" by market participants. Several
Goethe bonds have been issued in the past two years and more such bonds are to be expected
to be launched as the renminbi becomes more liquid.
Germany is Europe's largest economy and has the closest trade links with China. Due to these
close real economic ties between our enterprises, it is obvious that the settlement of payment
flows should be as efficient and thus as direct as possible. To this end, a clearing bank was
set up in Frankfurt last year that clears, for instance, payments made by German companies
to Chinese suppliers.
Large German enterprises have had a presence in China for quite some time now. However,
the ongoing opening of the Chinese market and the simplified clearing of transactions also
provides small and medium-sized enterprises a wide range of growth opportunities. It is likely
that these enterprises will step up their involvement in China even further in the future. Indeed,
a survey by a commercial bank2 has revealed that 17% of SMEs engaged in business with
China already settle their accounts in renminbi. Another 11% are said to be planning to switch
their invoices to the Chinese currency. These enterprises are hoping to gain advantages in
price negotiations as well as better market access. In addition, it means that enterprises can
better hedge exchange rate risks. With a clearing bank in their own country, enterprises can,
for example, settle accounts in their own time zone, in German and under German law while
still having a direct link to the Chinese payments system. In this way, payments can be settled
faster and potentially also at lower cost.
A direct connection is now also possible through the new China International Payments System
(CIPS). Participating banks have been able to settle their payments directly with China via this
system since 8 October 2015. The stability and efficiency of CIPS will have a decisive impact
on the future of the various pre-existing trading platforms. The same is true of the clearing
banks.
Legal risks for foreign enterprises are often cited as a problem for those wishing to expand
their business in China. The Chinese government, too, is aware of this problem. In February
2015, Prime Minister Li stressed once again that the climate for foreign investors in China
needed further improvement. The World Bank's annual Doing Business Report examines
business regulations in, at last count, 189 economies on the basis of 36 indicators. China is
currently ranked in 90th place. There is therefore still room for improvement. This can be
achieved, for instance, by forging ahead with agreements to use common standards and
dismantling barriers to market entry.
Achieving a mutual understanding of corporate culture in the various markets can be aided
through personal contact. More and more Chinese delegations are coming to Germany every
year. One of the objectives of these visits is to examine and gain an understanding of small
and medium-sized family businesses and their structures. After all, this organisational structure
is often cited as a blueprint in reforming the Chinese growth model - even though it could never
be adopted in every single aspect. In China, it is intended that a corps of small and
mediumsized private enterprises will provide "new", more qualitative growth and boost the innovative
power and competitiveness of Chinese enterprises. Over the past decade, China has been
attempting, through various channels, to support the established enterprises by offering fiscal
incentives such as tax breaks.
At a meeting between the Chinese President and the Federal Chancellor during the former's
visit in March 2014, both countries agreed to establish a high-level financial dialogue. This took
place for the first time in the spring of this year in Berlin. The aim of the meeting between the
finance ministries and the central banks is to institutionalise cooperation, also in financial
matters. This concerns, among other things, not only issues of financial supervision and
regulation, but also international cooperation within the G20. An outcome of the meeting is that
assistance is to be provided for investment by small and medium-sized enterprises and the
cross-border settlement of securities and derivatives is to be made easier.
I expect that these trade relations will become even closer and that financial relations, too, will
continue to deepen.