Chi on China Renminbi Gran Turismo (Part 3 of 3): The Rising Yuan in Seoul

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1 For professional investors 22 October Chi on China Renminbi Gran Turismo (Part 3 of 3): The Rising Yuan in Seoul SUMMARY After Beijing assigned two offshore renminbi (RMB) clearing banks in London and Frankfurt in July, it designated another clearing bank in Seoul. The latter will greatly expand the role of the RMB in bilateral trade and financial transactions in northeast Asia. South Korea has a natural advantage in accumulating RMB because it runs a trade surplus with China. Its involvement in the RMB markets should help broaden RMB internationalisation in northeast Asia as the momentum of China s collaboration with Japan has stalled. Developing financial infrastructure in South Korea will prepare it as an investment destination for Chinese firms. But if South Korea fails to fully exploit its advantages in the building of offshore RMB business, other offshore centres will benefit from the spill-over of Korea s offshore RMB liquidity. After marching to Europe with strong momentum (see part 2 of this series), the RMB has also set its feet in South Korea. The country has already amassed the fourth largest RMB pool in the offshore market (Chart 1). In July, Beijing assigned the Bank of Communications as an RMB clearing bank in South Korea and granted the country RMB80 billion in RQFII quota equal to that granted to France and the UK, and larger than Singapore s RMB50 billion. The usage of RMB for international payments has soared in South Korea, with total RMB payments in value terms rising by 563% year-on-year in June 2014 (Chart 2), according to SWIFT. In June 2014, 69% of all direct payments between China (including Hong Kong) and South Korea were made in RMB in June, up from 33% in June 2013.

2 RMB Gran Turismo (Part 3 of 3): The rising yuan in Seoul 22 October Chart 2: RMB (sent and received) payments value in South Korea source: SWIFT The clearing banks China has assigned allow it to control RMB liquidity overseas. So Beijing s move to designate clearing banks in offshore RMB centres before making its capital account fully convertible is a step towards fostering a new international monetary order with several global currencies by promoting the RMB (see part 2 of this series). Deepening RMB internationalisation The development of offshore RMB business in South Korea is crucial for deepening RMB internationalisation in northeast Asia because 1) China s collaboration with Japan to expand the RMB s role has stalled for political reasons, and 2) China runs a trade deficit with South Korea, which makes it conducive for South Korea to accumulate a large RMB pool for developing financial transactions in the currency. In December 2011, China and Japan entered into an agreement to promote the usage of RMB for trade and non-trade transactions. Under the agreement, China would allow Japan to 1) use RMB as an investment currency for its foreign direct investment into China, 2) develop a RMB/JPY foreign exchange market to

3 RMB Gran Turismo (Part 3 of 3): The rising yuan in Seoul 22 October facilitate trade settlements in RMB in Japan, and 3) encourage Japanese entities to issue RMB bonds in Tokyo. Japan would also invest in China s sovereign debt as an additional reserve asset. This Sino-Japanese deal could have boosted RMB internationalisation significantly because China runs a large trade deficit with Japan (averaging more than USD30 billion a year for the past five years). If more of this trade deficit were re-denominated in RMB, the resultant increase in the outflow of RMB to Japan would expand the role of RMB in northeast Asia and thus erode the dominance of the USD. However, the initiative failed to get off the ground due to the dispute over the ownership of the Daioyu/Senkaku Islands. Enter South Korea, with which China runs an even larger trade deficit than with Japan (Chart 3). If the Sino- Korean trade deficit were to be re-denominated in RMB, the potential RMB outflow to South Korea would exceed that under the Sino-Japanese collaboration. Among all the offshore RMB centres, China s trade deficit with South Korea is the second largest after Taiwan s (Chart 4). This gives South Korea the advantage of accumulating a large offshore RMB pool with which it can expand its RMB-denominated financial transactions to the point where Seoul would rival all other offshore centres except Hong Kong. (Hong Kong still enjoys unrivalled advantages in building the largest RMB pool as it has the largest amount of exports to China settled in RMB see part 2 of this series and enjoys preferential policy treatment from Beijing).

4 RMB Gran Turismo (Part 3 of 3): The rising yuan in Seoul 22 October Bilateral financial integration South Korea s large RMB pool will not only allow it to facilitate the use of RMB in bilateral trade, but also encourage the development of RMB financial transactions. Seoul s challenge is to expand and deepen its capital market to accommodate such new RMB financial business. The European offshore centres are very keen on developing RMB financial transactions, but they suffer from small RMB pools in local economies. However, if Seoul fails to fully exploit its natural RMB trade advantage, any other offshore centres that can offer better opportunities and returns could benefit from the resulting RMB outflows from Seoul as offshore RMB funds are highly fungible. From China s perspective, developing RMB financial infrastructure in South Korea should facilitate the currency s internationalisation through trade and the ability to hedge foreign exchange risks. It should also establish South Korea as an investment destination for Chinese capital as Beijing gradually opens its capital account. Chi Lo Senior Economist, BNPP IP

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