Asia's robust economic growth this year presents China with a pivotal opportunity to expand the RMB’s regional influence through the Regional Comprehensive Economic Partnership. Covering 30% of global GDP and 27% of merchandise trade, RCEP is the world's largest trade agreement. By capitalizing on tariff cuts and other incentives, China's imports and exports with RCEP members soared to $1,946bn in 2022, accounting for one-third of the nation’s total trade.

While RCEP has been heralded primarily as a means for China to increase RMB settlement in direct trade with partner countries, its enormous scope enables far-reaching RMB adoption beyond bilateral exchanges. Growth in so-called “third-country” use of the RMB—where non-Chinese entities use the Chinese currency to transact business with one another—is essential to elevating the RMB's international prominence and cementing its status as the dominant regional currency.


The dollar’s dominance

The dollar reigns supreme in third-country transactions today, representing 40% of global trade invoicing despite the US comprising just 10% of world trade. Nearly half of all European Union imports are invoiced in dollars, even though the US accounts for only 12% of EU imports. The greenback's popularity extends far beyond trade, with huge amounts of US dollar banknotes held abroad and the dollar serving as the dominant currency for quoting financial products worldwide.

In comparison, the RMB plays a negligible role by all measures. It comprises just 7% of foreign exchange market turnover, disproportionately low given China's outsized role in global trade. RMB deposits in major offshore markets represent a mere 0.5% of onshore deposits. Less than 2% of foreign corporate debt is RMB-denominated versus 63% for the dollar. RCEP could help alter this status quo.


RCEP remaking the landscape

Abundant theoretical literature has examined how economic factors influence the choice of invoicing currency. Two key determinants are (1) strategic price-setting complementarities, where exporters aim to keep prices stable relative to competitors, and (2) international input-output linkages, where exporters along the supply chain seek to limit deviations between marginal costs and marginal revenues to stabilize profit margins. A recent study by Mukhin (2021) develops a quantitative general equilibrium model that incorporates these determinants. It suggests that a large market creates incentives for foreign suppliers to invoice in local currency, which then propagates to other countries and products.

This line of reasoning could be applied to China. China is the world’s largest exporter, comprising roughly 20% of global exports. It possesses a vast network of suppliers enabling mass manufacture at low costs due to factors such as economies of scale and streamlined rules. Its sheer size incentivizes foreign suppliers in the RCEP bloc to invoice in RMB to align their prices with China-based competitors. This stabilizes RMB prices of inputs for Chinese producers, prompting them to invoice exports in RMB. Government support such as tax rebates could further encourage local currency invoicing. Over time, this could increase the share of inputs invoiced in RMB for producers outside China, inducing them to invoice non-China exports in RMB as well. Aligning invoice currencies across value chains mitigates volatility from currency mismatches.


Accelerating the transition - export similarity

The transition may be gradual given the dollar’s established dominance. Yet we reckon certain factors could help hasten the process, such as the rising similarity of exports. Over the past decade China and major Asian countries have increasingly similar export mixes, shifting towards higher value-added products. We examine this homogenization by using the Revealed Comparative Advantage indices (RCA), which is based on the Ricardian comparative advantage concept for calculating a country’s relative competitiveness in a product based on trade flows. A country is said to have a revealed comparative advantage if the value exceeds unity.

The plots presented below show China and major Asian countries demonstrated strong trade competitiveness in sectors such as electrical machinery and parts, critical for modern industries like telecommunications, transportation, and consumer electronics, as well as renewable energy technologies such as solar and wind power. Similarly, they have high RCA scores in the office and telecom equipment sector, which includes communication equipment, computers, and peripheral equipment. These sectors are critical for the digital economy and the development of smart cities.

With their strong RCA scores in these sectors, China and its regional peers are well-positioned to compete with each other in the global market. Our findings are consistent with prior studies confirming the increasing resemblance of Chinese exports with those of neighbouring nations. These countries specialize in exporting processed consumer and capital goods such as machinery & mechanical appliances, electrical machinery and equipment to Asia, the US and Western Europe (Lev, 2020).

Our RCA analysis supports the idea that China and other regional economies are developing increasingly similar export mixes. In undifferentiated markets, even small price differences can significantly impact market share, leading companies to invoice in the dominant currency to stabilize relative prices. For example, slight currency fluctuations could disadvantage companies against Chinese competitors in the electronics industry, which make up a significant portion of exports from China (44% of total exports), Vietnam (31%), and Thailand (46%). Therefore, firms in these countries are incentivized to invoice in RMB to stabilize relative prices.

This trend is reinforced by the proliferation of "China+1" strategies, where companies establish secondary production bases beyond China due to trade tensions and supply chain disruptions. Countries like Vietnam, Thailand, and Malaysia have introduced tax incentives and other policies to attract overseas investment from companies looking to establish additional manufacturing hubs.  Huawei, Lenovo, Haier, Nike, and Foxconn are among the multinational companies that have shifted manufacturing to Southeast Asia from China over the past few years.

Such adjustment is evident in value-added data, with the share of imported content from China in Vietnam's exports rising from 4% in 2000 to 20.3% in 2021. This suggests that while some parts of the value chain are relocating from China, companies may still retain Chinese suppliers for certain inputs due to cost and/or efficiency considerations. The US trade data helps shed more light. China’s share of US manufactured imports fell 5%ppts between 2018 and 2022, while imports from other Asian developing countries rose equivalently. Especially large increases were seen in semiconductors, computer accessories, and telecommunication equipment – categories where US imports from China declined.

The upshot is that when companies diversify regionally while keeping China included, countries tend to specialize in producing components and intermediate goods that complement China's manufacturing. This likely increases the similarity of China/ASEAN's export mixes, reinforcing motivations to stabilize relative prices by aligning invoicing in the RMB.


Accelerating the transition - RMB stability

Improving exchange rate stability bolsters RMB’s appeal, too. Currency stability is essential for businesses choosing a currency for trade payments. A stable and low-volatility currency reduces revenue and cost fluctuations resulting from exchange rate movements, facilitating financial projection. The RMB's increasing stability—with USD/CNY volatility declining to around 5.4% in 2016-2022, lower than major currency pairs—makes it an appealing choice. At the onset of the COVID pandemic in early 2020, regional currencies declined steeply against the dollar. The RMB saw pressure but fared better than its counterparts. Policies such as adjusting foreign exchange reserve requirements and the counter-cyclical factor have buttressed RMB stability.

The increasing use of the RMB in energy settlements could further anchor its value to tangible demand, boosting the case for broader adoption. While data on settlement currencies in China's energy trade is limited, anecdotal evidence points to rising RMB usage. Recently, China completed its first purchase of imported LNG priced in RMB through the Shanghai Oil and Gas Trading Centre platform. Approximately 65,000 tonnes of LNG imported from the United Arab Emirates were transacted in the deal. Meanwhile, the pivot to RMB-denominated oil and gas contracts with China has propelled Russia from outside the top 15 largest RMB offshore trading hubs in 2021 to the 5^th largest in February 2023. Strengthened China-Saudi ties also increase the prospects of RMB in oil pricing. China purchases over a quarter of Saudi oil exports. Pricing even some of this in RMB could spur the development of "petroyuan", stabilizing the currency and supporting wider acceptance.


Accelerating the transition - policy support

Continued policy action can further advance the RMB's regional usage. Of the 28 offshore RMB clearing banks, 13 are located in Asia-Pacific including Singapore, Malaysia, Thailand, Japan, and South Korea. They facilitate offshore RMB trading and cross-border payments through onshore forex market access. China’s state-owned banks have in recent years launched affiliates across the region and offered forex services for domestic firms and banks, working to develop forex markets for RMB pairs with Southeast Asian currencies.

Beijing has established bilateral currency swap agreements with nations spanning the region, with the stated objective of facilitating use of the RMB in trade invoicing. Access to the RMB swap not only allows the recipient country to finance any deficit in current and capital account transactions with China, but also settle trade with non-China counterparties. Doubling down on these initiatives by swelling offshore liquidity via additional swaps could fill the dollar liquidity gaps as the Federal Reserve tightens, further enhancing the RMB’s allure. For China, swaps diversify reserves by exchanging RMB for foreign currencies investable in non-US sovereign bonds. With outstanding swaps comprising only 20% of China's USD3.1tn forex reserves, potential to expand remains significant.


Conclusion

In sum, RCEP provides China an essential platform to motivate broader third-party usage of the RMB. As regional economies integrate while preserving close ties to China, the incentives for adopting a stable regional currency for settling trade beyond direct Sino-transactions are growing. China’s dominant role in regional trade and supply chains alongside RMB’s increasing stability have enabled its rise as an option for regional and third-party payments.

The recent proposal by ASEAN to reduce dollar reliance represents a propitious opportunity to promote greater RMB use. Beijing could capitalize on this by highlighting RMB invoicing benefits such as lower transaction costs and reduced currency risk, and by offering incentives for ASEAN countries to adopt RMB. Additionally, as China strengthens economic ties with ASEAN countries through policies like the Belt and Road Initiative, RMB could become more attractive for both parties. While capital controls and the dollar primacy remain hindrances for the RMB, extending its use lies within reach given RCEP’s collective weight. Regional prominence may present China’s clearest path to securing the RMB a place among elite currencies.


References
Georgios Georgiadis, Helena Le Mezo, Arnaud Mehl, Cedric Tille, 2021. Fundamentals vs. policies: can the US dollar’s dominance in global trade be dented?
Mukhin, D., 2021. An Equilibrium Model of the International Price System.
Lev Vlasenko, 2020. Evaluation of the composite export similarity index on the example of China.


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Nathan Chow 周洪禮

Senior Economist and Strategist - China & Hong Kong 高級經濟學家及策略師 - 中國及香港

[email protected]