RMB 'limited' as a trade currency

The recent financial crisis increased China's ambition for further reform at a faster rate than expected, according to Huw McKay, Westpac's deputy global head of economics. However, the pace of reform, particularly in the financial sector, cannot be taken for granted, he warned.

Speaking ahead of a panel discussion in Sydney on the theme of "Unlocking the Potential of the RMB", McKay suggested that having the renminbi as another trade currency is useful, but it would take large cross-border investment in both directions to give the foreign exchange market in RMB any level of depth and activity

McKay said he expected China to follow a similar trajectory to that shown by Japan, which has invoiced in the home currency of its export markets. This has limited the yen as a trade currency to no more than 40 per cent of Japan's total export volume.

"What is really going to affect FX turnover and real underlying demand for hedging activities is international connectedness and integration," said McKay. "Once a country starts owning a lot of assets in other countries, and investment flows in both directions, that's when there's a big financial market multiplier."

The rise of the RMB is likely to cause a decline in the demand for the Aussie dollar, which had been enjoying several good years as a safe haven currency.

"The renminbi has become the largest regional trading currency and the seventh largest trading currency in the world," noted Naomi Fink, chief executive of Europacifica Consulting.

"The Australian dollar has been used as a proxy for exposure to China and the RMB. If the RMB becomes a reserve asset, it is possible that the Aussie will be pushed a little bit lower. Certainly we going to see a lot more trading between the two currencies."

The effect on the Australian dollar, in terms of displacement by the RMB, nevertheless, remains an open question, she suggested - a point picked up by Emma Lawson, senior currency strategist at National Australia Bank.

"What we need to see is the development of [an RMB] market with greater depth and liquidity. And knowledge - there isn't a lot out there and the market is moving faster than people realise. Once you get people up to speed they will be more confident in the market will take off," Lawson suggested.