Taiwan – the next potential renminbi offshore centre

A research report released by BBVA states that Taiwan would not be a competitor for London, Singapore and Hong Kong since the CNT – coined after Hong Kong’s CNH – would only serve the needs of Taiwanese-Chinese economic relations. “Unless the Chinese authorities give crucial importance to Britain’s financial expertise – be it London or its two former colonies, Hong Kong and Singapore – we argue that Taiwan would be as good an option to become an offshore renminbi centre or even better,” says Alicia Garcia-Herrero, chief economist for emerging markets at BBVA.

Taiwan has much stronger economic links with China than Britain or even Singapore, notes BBVA. The improvement of relations between the two led to the enactment of a preferential trade agreement to reduce tariffs and commercial barriers in September 2010, named the Economic Cooperation and Framework Agreement.

China is estimated to have received $6.7 billion of direct investments from Taiwan in 2011, more than double US’s $3 billion and marginally higher than Europe’s $6.4 billion. As at January 2012, 2.6% of trade between China and Taiwan is settled in renminbi – also known as the yuan – after Hong Kong’s 63.6% and Singapore’s 7.7%.

The figure for foreign direct investment (FDI), on the other hand, is unknown.

“Although there is no information on how much of the renminbi holdings in Hong Kong are in the hands of Taiwanese, the long-standing economic linkages between China and Taiwan would indicate that such holdings may constitute a significant share,” says Garcia-Herrero. “This is even more the case if one considers that Taiwanese have long been using Hong Kong for its trading and FDI into China.”

Moreover, similarly to Hong Kong, Taiwan has been accumulating the Chinese currency and by no means is the nation’s financial system small, as it gathers a large pool of savings in its investment and insurance companies.

The potential creation of the CNT market would increase investment options for Taiwanese investors who are keen to tap into products denominated in the Chinese currency.

“Creating a CNT market would not only facilitate renminbi settlement for trade purposes while saving firms from exchange risks and transaction costs, but also open up the avenue for renminbi-denominated wealth management businesses,” adds Garcia-Herrero. “In fact, renminbi products would offer additional currency diversification gains to Taiwanese savers.”

China’s tight controls on capital inflows and outflows create difficulties for Taiwanese companies operating in China to repatriate their profits back to Taiwan, says BBVA. The non-convertibility of the Chinese currency and the associated transaction costs make it worse.

In addition, neither the renminbi nor Taiwanese dollar (TWD) carries any official status in each of the jurisdictions. Today, the exchange, supply and repatriation of the Chinese currency and TWD are conducted through Hong Kong banks as correspondents.

“The starting point is basically of no currency recognition for two areas with huge economic relations,” says Garcia-Herrero. “This makes the gains of creating a CNT offshore centre potentially very large. If anything, it would bring many of the underground economic activities across the Strait to the surface.”

Creating an offshore renminbi centre for Taiwan would present several benefits to China.

Having one more renminbi offshore centre would help accelerate the process of internationalization of the Chinese currency. BBVA also adds that the difference between Taiwan and London or even Singapore is that a substantial part of the renminbi to be deposited in Taiwanese banks would be non-speculative in nature given the two areas’ strong trade relations.

“Looking at the nature of Chinese trading partners, it seems clear that Taiwan and Hong Kong have very distinct features, namely Taiwan is manufacture-based while Hong Kong is relatively finance-oriented,” says Garcia-Herrero.