May saw China and Australia agree a deal to directly trade the Australian dollar and the renminbi. Andy Seaman, Partner and Portfolio Manager, Stratton Street, explains that this means that rather than foreign exchange between the two countries going via US dollars, the currencies can be directly converted, something that previously was only possible with the renminbi and the yen. The Reserve Bank of Australia, Australia's central bank, is the first to sign up and has put 5% of its foreign exchange reserves into the renminbi.
Seaman explains that this might have come as a surprise to people in the markets here but other central banks are queuing up to do just the same. "This is a trend that will continue" he says, with the Banque de France and the Bank of England also keenly creating links with China, albeit constrained on what they can do with their foreign exchange reserves.
"The renminbi has come from nowhere" Seaman explains but by 2015 it is predicted to have a trading volume of $1tln a day and be standing at number three in the world's most actively traded currencies. Globally, 12% of China's trade is now settled in renminbi. "If recent initiatives are able to boost trade in renminbi to match either the current - 12% - level of trade settled in renminbi seen other parts of the world, or approach the one third level within a few years, then this would represent a sizeable change which can only be positive for Australia".
China is Australia's largest export market accounting for just under a third of Australia's exports so there is clearly a strong incentive for Julia Gillard's government to develop strong relations with Beijing.
If the predicted growth in the strength of the renminbi is correct the currency will exceed the projected daily trading volume of the Australian dollar, Sterling and Singapore dollar combined by 2015. "This is more a story about the rapidly growing importance of the renminbi in global financial markets of which Australia plays an important, but small part, than it is a story about Australia" Seaman says.
Stratton Capital's Renminbi bond fund has seen similar stratospheric growth, launching in 2007 with just $2m under management and now standing at $385m. Performance since launch clocks in at 92.96% and it stands at the top of bond fund league tables over five and three years.
The Chinese bond market is still restricted, unless you have a quota so access is limited, pushing custom through Stratton Street's fund approach, which is based on dollar bonds hedged into renminbi.
Seaman holds strong views on the Aussie dollar. "Australia holds the dubious distinction of having run a current account deficit for the past 30 consecutive years. Put another way, the country has been consuming more than it earns for three decades and has borrowed from abroad to finance its overconsumption. The net result is that the country as a whole owes more than 50% of GDP to foreigners or, put another way, the net foreign liabilities of the country are in excess of 50% of GDP. Countries with debts above that threshold frequently get into trouble and often see very sharp falls in their exchange rates" he says.
"We consider any country with net foreign liabilities in excess of 50% of GDP and rising to have unsustainable debt dynamics and be not worthy of an investment grade rating. It will come as shock to many when the country loses its Aaa rating, which we regard as inevitable if the country continues to spend more than it earns."
In comparison, China has enormous overseas assets, runs a current account surplus and market rates are around 2.5% in the offshore CNH currency market. Seaman reports that it is also a far more stable currency with longer term volatility being around one tenth of that of the Australian dollar.
(This piece first appeared in Opalesque, May 16th)
This article was published in Opalesque's Asia Pacific Intelligence our monthly research update on alternative investments in the Asia-Pacific region.