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By Anthony Harrington

What does any nation with a significant amount of trade with China want? Probably many things, but a free floating renminbi exchange rate would be high on the list. China knows that the pressure is mounting and it has been doing some reasonable things, such as agreeing with Japan and with Hong Kong that there should be more settlement in RMB. The latest move, announced on 8 April, is direct trading between the Australian dollar and the renminbi.

This last move makes the Aussie dollar only the third currency to be able to trade alongside the renminbi, the other two being the US dollar and the Japanese yen. This follows up the US$2 billion currency swap facility established between Australia and China in March 2012. However, most trade between Australia and China is still settled in US dollars.

Deputy Governor Philip Lowe, in a speech in Shanghai on 24 April this year argued strongly for Australian companies to do a lot more invoicing in renminbi. He told the Shanghai Chamber of Commerce that there are five elements that define the financial relationship between Australia and China. Number one on his list was settlement in renminbi:

There is "the potential for a substantial increase in the share of trade between our two countries that is invoiced in RMB," he told his audience.

Australian businesses currently have the option of invoicing in RMB, but take up has been slow. Part of the reason for this is that it remains difficult to hedge out RMB currency risk. The Australian dollar is a heavily traded currency and pretty volatile. An unhedged Australian business could easily see most or all of its profit margin eaten up by adverse currency movements if it invoiced in RMB, even if that would make selling into China a very much easier proposition on occasion.

The RBA deputy governor reckons that it is inevitable that "deep and liquid markets (in the relevant financial instruments) will develop, settlement processing will be improved and the appetite for invoicing in RMB will grow. "If this assessment is correct, then it is likely the RMB will become the invoicing currency of choice for many businesses on both sides of our trading relationship," Lowe commented.

In 2012-2013 some 26% of Australia's imports went to China and 15% of all Australia's imports came from China. Australia's chief export to China is iron ore, but a range of other commodities and value added goods flow from Australia to China, to the point where Australia accounts for around 5% of all China's imports.

"As trade linkages increase, firms require an increasing array of financial services. And a strong trading relationship helps businesses in both countries identify and develop investment opportunities in the other," he said.

At the moment most countries trading with China use the US dollar as the intermediary currency, with each side translating into dollars for settlement. This is clearly cumbersome and leaves one or other of the parties open to currency risk should the dollar exchange rate move against them. The closer China moves towards floating the renminbi, the easier it will be to bring all the usual financial instruments to bear to hedge out FX risk, which should help encourage still more companies to explore the possibilities of trade with China.

Source: Australian Trade Eyes The Renminbi