China has just reached a new milestone. On October 1, the renminbi (RMB) debuted as an official currency in the International Monetary Fund’s Special Drawing Right (SDR) basket, joining the club of reserve currencies led by the dollar and used worldwide. The achievement is a major step in China’s policy to globalize its currency and create the necessary infrastructure for using RMB in trade, investment and financial operations. It can also be a game-changer for developing markets, especially in Latin America.
Over the past decade, China has become one of the main trading partners for most economies in the region, particularly in the southern cone. These include Argentina, Brazil, Chile, and Peru. Chinese foreign direct investment has been critical for developing infrastructure projects throughout Latin America. Chinese companies have built electric transmission lines in Brazil, hydropower plants in Ecuador and Bolivia, railways in Argentina, telecommunications infrastructure in Chile, and several projects in Venezuela – from hydropower plants to electric transmission lines and reforms in ports.
Over the past five years, we have observed an increase in the presence of Chinese banks and RMB operations in Latin America. The big four state-owned banks are present in the region, providing a foothold for greater transactions across the Pacific. China has also signed financial exchange agreements and established mechanisms to facilitate foreign institutional investment.
But what does that mean for Latin America?
As stated in a new report by the Atlantic Council’s Adrienne Arsht Latin America Center, an internationalized RMB can be an opportunity for Latin American countries to diversify their sources of finance. The report, “A Globalized Renminbi—Will It Reshape Latin America?,” argues countries and companies can issue RMB-denominated debt, which may lower their financing costs. This is particularly true for countries with constrained access to the G3 (dollar, euro, yen) markets, though this also raises risks on both sides.
Trade between China and the region also stands to gain. Trading in a local currency offers significant cost savings: It avoids the transaction costs that result from using a third currency, such as the dollar, and may bring discounts when dealing with Chinese firms. Although China–Latin America trade has decelerated in the past two years, the outlook points to robust commerce. RMB pricing also helps companies tap into the massive Chinese market and into a consumer class greater than the United States and European Union combined.
But not everything is rosy. One potential outcome is an increase in the risk of Chinese investments in Latin America. This is particularly problematic if RMB use in fact means companies and countries that do not meet international borrowing standards have access to finance. A separate concern is the political tensions that come with a greater Chinese presence. Such tensions have already arisen in African countries, where China is the preeminent foreign force today.
Other challenges exist. So far, the numbers do not match China’s efforts to promote the RMB in Latin America. Today, less than one percent of the region’s trade with China is RMB-denominated, whereas 26 percent of China’s trade with the world is RMB-denominated. The reason is simple: China’s imports from Latin America consist mainly of commodities, where prices are determined by international markets and are already negotiated in dollars. Switching to RMB would require rewriting contracts denominated in dollars. At the same time, a lack of RMB liquidity is seen throughout the region, and both sides will need to address it.
To uncap the potential benefits from RMB usage, both China and Latin America need to improve this growing partnership. Latin American exporters need to assume more risk and engage in operations to access China’s vast domestic market. Regional banks could increase their activities in China, which would boost the confidence of Latin American exporters and mitigate cultural gaps. Hong Kong would be an ideal starting point for entering the Chinese market; it brings deep links to mainland China and has a central position in global RMB markets.
On the other hand, Chinese banks could increase their capital in the region and make efforts to culturally adapt to Latin American business standards. Lastly, governments from the region and China should keep moving forward in creating the institutional and operational infrastructure for local currency trade, investment and financial operations. This includes expanding the number and volume of swap agreements, and increasing the number of clearing houses. Such efforts could yield tremendous benefits for Latin America. This is a new horizon, but we are at a critical moment to help Latin America use the rise of the RMB to promote regional growth.
André Soares is an Atlantic Council author and former research director at the China-Brazil Business Council. Douglas W. Arner is an Atlantic Council author and a professor of law at the University of Hong Kong.