Bernard Hickey: Reality of renminbi

Our economic future is clearly in the China camp, so we should care a lot more about the relationship between our currency and the Chinese renminbi or yuan.

Yet most people in business or investing would struggle to say what the rate is or even to have traded it. This week the New Zealand dollar will buy about 5.3 renminbi - not that you'd know it, because it's hardly ever reported or shown in bank windows.

This is despite China being our second-largest trading partner behind Australia, the fourth-largest source of short-term visitors behind Australia, Britain and the United States, and the third-largest source of migrants behind Australia and Britain.

The Chinese renminbi is a strange beast. It is not easily convertible and has essentially been pegged to the US dollar at various rates for years.

Many believe China has set the value of its renminbi at an unrealistically low level against the US dollar to help boost its exports and build up huge trade surpluses. The proof of that has been China's rapid accumulation of US$3 trillion (NZ$3.6 trillion) worth of foreign reserves since 2005. It is still building up reserves at a rate of US$400 billion a year.

But this is changing. China has allowed the renminbi peg to crawl about 5 per cent higher a year against the US dollar since 2005. China is starting to use this appreciation to help reduce inflationary pressures. It is also moving to "internationalise" its currency by encouraging its importers and exporters to invoice in renminbi. About 10 per cent of Chinese imports are now invoiced in renminbi and this is expected to more than double over the next few years.

But there is a long way to go. Less than 1 per cent of the world's foreign-currency transactions are in renminbi.

China needs to create large and liquid markets in renminbi-denominated securities to boost the use of the currency. China has quietly allowed some banks in Hong Kong to start issuing "Dim Sum" bonds on behalf of various companies. Fonterra was the first New Zealand company to issue these bonds. It raised $56 million worth of renminbi through a three-year bond issue yielding 1.1 per cent in June.

China and Britain also announced this week they would develop a trading hub for renminbi in London, the world's biggest foreign-exchange trading centre. Germany is also pushing for the renminbi to join the International Monetary Fund's Special Drawing Rights programme, which some believe could eventually act as an alternative reserve currency to the US dollar.

This issue of a reserve currency is at the heart of the tension between China and the US. Even though the size of China's economy is expected to pass the US's by 2020, most believe the US dollar will remain the reserve currency for longer.

That's because the US has the most liquid financial markets with enormous amounts of bonds on issue. China's Government would need to borrow heavily to match the US. But the real reason is that China doesn't trust financial markets. It wants to retain the ability to use its currency to grow its economy.

For now, then, we should get used to the renminbi being an undervalued currency that we hardly use. But China will become an increasingly heavy buyer of foreign assets as it tries to diversify away from its reliance on the US dollar.