CHINA’s market liberalisation means South African companies can now invoice and settle in Chinese yuan. The uptake on this new opportunity has been slow but we are seeing a steady growth in interest and this is clearly the way of the future.
While it is well known that South Africa’s trade with China has grown exponentially, the numbers are nevertheless staggering: from practically zero in the late 1990s, we estimate last year’s trade should have totalled almost $30bn. China is now South Africa’s most important trade partner, accounting for 16% of imports and 14% of exports. Until recently, all of this trade was denominated in dollars. It had to be as there was no other choice. There is now.
China’s economic reforms took off in the 1980s but it was less than a decade ago when serious financial market liberalisation took place. The first major step on the currency front came in July 2005, when the yuan was unpegged from the dollar. The yuan remains completely controlled, but over the years the authorities have allowed substantial currency appreciation and also increased two-way volatility. This implies that Chinese companies are now exposed to growing exchange-rate risk.
The next key step on the currency front came this decade, with the internalisation of the yuan through the creation of an offshore market. This is the so-called CNH market, the "H" denoting Hong Kong, which was the first offshore centre allowed to trade yuan and which still dominates trade. This is the market that offers so much opportunity for corporate South Africa.
The CNH market is staggeringly complex. This may well be a factor preventing South African firms from fully grasping the opportunities the market offers. But it shouldn’t: the complexities are behind the scenes and need not complicate a company’s life. Indeed, trading in Chinese yuan is now as straightforward as in any other currency. Settlement is the same, forward markets allow for similar hedging and, as elsewhere, receipts and payments can be held in a customer foreign currency account — but forget the jargon, the key is that you can now trade yuan.
The attraction of using this new market for invoicing and settlement is straightforward. Just as trade with Europe is denominated in euros, so it makes sense that trade with China is in yuan. The Chinese counterparty would certainly be happy: with yuan invoicing they would have no currency risk compared with the present system, in which they are exposed to the dollar-yuan exchange rate. Substantial benefits can also accrue to the local South African company. We’ve found that Chinese counterparties are often happy to give price discounts to have the currency risk removed. And, given that the slight moves seen in the yuan are correlated with the more extreme moves in the rand, rand-yuan volatility and risk are lower than in dollar-rand.
Despite the win-win situation of dealing in yuan, we’ve found that Chinese-South African trade has been slow to adjust. As much as 20% of China’s total trade is now invoiced in local currency. Yet, while we have carried out numerous yuan transactions for our clients, and seen even more interest, the local number is probably closer to 1%. Part of this resistance comes from the Chinese side. The newly internationalised market is not always well understood by smaller companies and the benefits need to be explained. This is at least changing quickly as participants become more comfortable with the market.
More resistance comes from local companies. Certain large retailers have been quick to grasp the new opportunity — understandably, given the importance of Chinese suppliers — but outside of this sector it’s only those with the most advanced treasuries that have made much headway. This will change. Yuan trading is undoubtedly the way of the future. The Chinese authorities are aiming for Shanghai to become an international financial centre on the scale of London or New York by 2020. This is an ambitious plan and necessitates the development of local financial markets, and so the full liberalisation of the yuan market. We don’t believe the yuan will be able to compete with the dollar as an international currency so soon, but it is quite likely that it will surpass the yen and sterling in importance and even compete with the euro as the world’s second currency.
The yuan will likewise become an important currency in South African markets — we expect exponential growth over the next few years. By 2020, expect your local newsreader to announce the rand-yuan rate just after the dollar-rand.
• Cairns is the currency strategist at Rand Merchant Bank.