February 2010 Archives
One of the key aspects of any cross-border trade is the decision of which currency to use. Despite the increasing prominence of China’s economy – poised to become the world’s second-largest economy and recently becoming the world’s largest exporter – use of China’s currency, the Renminbi (RMB), has failed to achieve similar distinction in international trade. Here an attempt will be made to evaluate the overall trend of the RMB’s use in the global marketplace.
Government imposed currency controls have gradually been reduced in China in order to enhance the RMB’s appeal. As of 2008, revenues from commercial transactions are fully convertible. In fact, all current account transactions – including international payments – have been eliminated. For private accounts, the limit for converting RMB into foreign currency has been raised from USD 10,000-USD 20,000 to its current level of USD 50,000.
Besides the easing of restrictions, China’s government has also advanced several initiatives to increase usage of the RMB internationally. In April 2009, the China Foreign Exchange Trade System (CFETS) was launched in conjunction with Reuters. This system allows member banks to trade the RMB against the US dollar, the yen, the Hong Kong dollar, the euro, and the pound sterling. Then in July, five Chinese cities – Shanghai, Guangzhou, Shenzhen, Zhuhai and Dongguan – were authorised to settle international transactions in Chinese currency. Through these conduits, the RMB is being promoted for use in trade with Hong Kong and ASEAN nations. Also in 2009, China’s government engaged in currency swaps with Argentina, South Korea, Indonesia, Hong Kong, Malaysia and Belarus. The central banks of these countries now possess RMB 650 million worth of foreign exchange reserves to facilitate trade using China’s currency.
The results from these policy changes are still pending, yet data from the Bank for International Settlements (BIS) shows that the RMB is traded far less frequently than many of the world’s other currencies. As of 2007 the RMB was ranked 19th, behind even Poland’s zloty, the Danish krone and the New Zealand dollar in terms of exchange frequency. Average daily turnover for the RMB has been increasing, however, whereas trade in major currencies such as the yen and US dollar have declined. As a result of policy changes, in Hong Kong deposits denominated in RMB have increased - from RMB 895 million in early 2004 to RMB 62.7 billion at the end of 2009.
To view the trend in currency usage from another angle, with more recent figures from the IMF, one can observe the composition of foreign reserves held at central banks. Although still an overwhelming favorite of central banks, holdings of the US dollar have fallen from a high of 56% of total counted reserves to around 36% as of Q3 2009. Similarly, the yen has declined from 5% to just under 2%. The share of ‘other’ currencies – the catch-all category that would include the RMB – has increased, but only to 1.7% of all foreign exchange reserves.
Note: Unallocated, according to the IMF, is the sum of the total reserves from non-reporting countries, and discrepancies between reporters’ data as reported to COFER and to International Financial Statistics.
Source: IMF COFER; THE BEIJING AXIS Analysis
With the US dollar and yen gradually giving way (perhaps given its recent troubles, the euro as well), the trend – although unwinding only incrementally – seems to be one toward a wider array of currencies in use internationally. This shift, along with China’s policies for further integration with the world’s financial markets, will continue to increase the role of the RMB in cross-border trade, although not as rapidly as other aspects of China’s economy.
Beyond language and legal barriers, such as the requirement of GOST R certification, businessmen have to consider another important issue: payment terms. This is especially true given that Russia’s economy is still suffering from the financial crisis, recovering more slowly than other countries. Establishing acceptable payment terms can cause substantial delays to the progress of a deal.
There are three aspects of the payment process which tend to produce problems when setting the terms of trade between Chinese and Russian companies.
1. Russian buyers traditionally prefer to settle trades through cash.
2. The Russian banking system has yet to mature. By the end of 2008 there were approximately 1,300 banks in Russia. Over 800 of these were extremely small, with a capital base equivalent to less than USD 1 million. An extra element of disorder exists in Russia’s banking environment, in that many banks have a reputation for not honoring issued letters of credit. Furthermore, one-third of Russia’s banks may face bankruptcy as a result of the crisis; solvency is an important consideration when choosing a Russian bank’s services.
3. The level of cooperation between Chinese and Russian banks has yet to fully develop. Communication between both sides is inefficient. Chinese banks lack enough representative offices and agents in Russia, and vice versa.
Hence the situation suggests that extreme care must be taken when making payment arrangements for a Chinese supplier exporting to Russia. Some important steps to take include requiring the buyer to use a top, recognisable international bank when issuing the letter of credit, and asking for a risk-adjusted down payment when establishing the terms of trade. Additionally, the supplier may consider using the services of a company such as Sinosure which insures letters of credit against business and political risks. This type of service incurs extra charges but may be worth the cost for large traded values.
Just like any other prospective new market, Russia presents its own unique challenges. By overcoming the language barrier, by obtaining certifications to reduce the perception of poor quality and by taking extra precautions regarding the terms of payment, Chinese suppliers can prosper from increasing bilateral cooperation with Russia.
This blog posting was inspired by the cold Beijing winter and a recent conversation with my roommate. After having lunch together, my roommate, a native of Shenyang in China’s northeast, described what she and her family ate during the winters of her childhood. Fresh fruit and vegetables were scarce to nonexistent; large quantities of Chinese cabbage and pears were bought in late autumn and had to last all winter. The pears were frozen, which caused them to turn black. The cabbage was either dried or put in jars to make “sour cabbage”. Meat was a luxury.
Having only two food choices available for one-fourth of the year sounded terrible to me. “So what did you eat in winter?” she asked. Well, I ate the same things as in the summertime – except maybe more cups of hot chocolate. Although winter likewise halted regional agricultural production, bananas, broccoli, seafood – you name it – managed to find their way to grocery stores in the American Midwest – where I grew up.
How could our childhood experiences in the 80s and early 90s have been so different? At least part of the disparity may be due to differences in the availability of transportation within China and the US.
As anyone involved in sourcing knows, although goods may be available in one location, the challenge remains of connecting them with their prospective end users, often many kilometres away. The greater the ease of connecting point A to point B, the cheaper the cost, hence, the more feasible trade becomes. This process requires infrastructure.
China has done a lot to improve its infrastructure since the 1980s. When imports arrive from overseas, they usually do so by boat. Not only does China now host some of the world’s busiest ports, but it has also has increased the length of its navigable inland waterways from 101,000 kilometres in 1985 to over 110,000 in 2008. From these inlets, the goods must then traverse land to reach their destinations. To this end, China has upped its railway length to 80,000 kilometres, as of 2008, from 55,000 in 1985. Even more substantial is the increase in highway availability, now at around four million kilometres, an increase of almost 300% from only 20 years prior.
The result of these advances in infrastructure: more goods are able to make it across the Chinese mainland to the people that need them. The amount of freight traffic within China, measured in ton-kilometres, has increased more than three times its 1987 value. Just as the wintertime shelves of the grocery stores in my hometown are filled with goods from the warmer southern US states, Mexico, and South America, similarly those in Shenyang can now be more readily stocked with products from southern China, the Philippines, or elsewhere.Source: China Statistical Yearbook; US Bureau of Transportation Statistics: US Census Bureau; Beijing Axis Analysis
The increase in transportation channels has reduced the contribution of shipping costs to goods’ retail prices, lessened the impact of food expenditures on one’s budget, and has enhanced the well being of Chinese consumers. This is evident when comparing the Engel’s coefficients – the percent of the typical household’s income spent on food, used as a general measure of a country’s standard of living – between China and the US. This statistic suggests that my roommate’s family may have spent about 55% of their household income on food in the 80s. The affect of both rising incomes and greater transportation availability since then have reduced this to less than 40%.Source: China Statistical Yearbook; US Census Bureau; Beijing Axis Analysis
It is interesting to consider how much more this is likely to improve in the future. I think for the Chinese New Year I will indulge in a little variety and buy my roommate both oranges and pears – fresh green ones– to celebrate the holiday and the progress made by China.