Crossing the river by feeling stones - China's internationalisation of the RMB


The announced currency swap agreement between the RBA and the People’s Bank of China is a positive step forward in Australia’s relationship with our largest trading partner. These days China alone accounts for around one-fifth of our international trade flows.

The swap agreement allows for the exchange of local currencies between the two central banks of up to A$30 billion and RMB 200 billion for an initial period of 3 years. It will provide important support to Australian companies considering using the renminbi as a settlement currency and further facilitate trade and investment flows between the two countries.

In the past China’s restrictive foreign exchange policies have been heavily criticised for being out of step with its developing position as a world economic power. Indeed the ongoing control of the RMB’s value and the fact that it is not freely convertible has been viewed by some as a concerted effort to keep the RMB undervalued to support China’s manufacturing industry. In December 2011 the US Treasury reiterated its concerns about the pace of appreciation of the RMB.

However, since 2008 the Chinese Government has embarked on policies to gradually internationalise the RMB. These efforts have resulted in the currency’s global status growing rapidly, especially in the areas of RMB-based cross-border trade and direct investment.

Liberalisation policies have included the issuing of RMB bonds in Hong Kong, the introduction of a scheme permitting cross-border settlement in RMB, allowing qualified foreign institutional investors to invest up to RMB 20 billion offshore in domestic securities and entry into bilateral currency swap agreements.

The importance of bilateral currency swap agreements to the development of the RMB as medium of exchange, store of value and unit of account should not be underestimated. Since the collapse of Lehman Brothers, China has signed 18 currency swap agreements with reserve banks of countries including South Korea, Iceland, Pakistan, the United Arab Emirates and Turkey. 

Bilateral currency swap agreements are not new and have their roots in the 1960s. In the past, bilateral currency swap agreements have been used as a way to deliver an emergency loan from one sovereign to another facing a debt, banking, or currency crisis. For example, in 2000 following the Asian currency crisis, bilateral currency swap agreements between ASEAN countries and the three East Asian economic powerhouses: South Korea, China and Japan were established. While most of these swaps were effectuated in US dollars, some were also in RMB.

The latest bilateral swap agreements entered into by China were initially intended to deal with the global financial crisis. However, their role is changing. They now appear to being crafted as a method to promote bilateral trade and direct investment between China and each partner in local currencies and ultimately the internationalisation of the RMB.

China’s path towards currency liberalisation took another step forward this week when its central bank widened the RMB’s trading band against the US dollar from 0.5 per cent to 1.0 per cent, further loosening its grip on the RMB.

While the focus in China is now turning toward necessary political transition ahead of the Communist Party leadership change in October, the currency measures undertaken by the central government once again highlight the Asian giant’s innovative and unique ability to bring about change through a strategy of “crossing the river by feeling stones”.

The content of this publication is for reference purposes only. It is current at the date of publication. This content does not constitute legal advice and should not be relied upon as such. Legal advice about your specific circumstances should always be obtained before taking any action based on this publication.

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