Senior executives of US firms doing business with China welcomed the recent decision by the Chinese authorities to facilitate the convertibility of the Chinese currency RMB. They expressed optimism that this important policy change will help promote US-China trade and economic cooperation but cautioned that its impact may be limited, and that corresponding changes are necessary in other parts of China's financial industry.

Convertibility Opens up the Market

With RMB becoming more convertible, American banks and investors will be more willing to conduct business with China. In the past, some investors were hesitant in investing in China for fear that they would not be able to get their money out.

A convertible RMB will make the China market more attractive and open more doors for trade between the United States and China. Just like some other Asian countries, China is a high-risk and high-profit market. RMB convertibility is definitely a right step to invite more people to invest in China.

A free RMB will make more American corporations ready to do fixed- and long-term investment in China. In addition to increasing exports to China, US firms will be willing to set up more joint ventures to produce locally.

Convertibility Removes Protectionism

The lack of convertibility was an effort by the Chinese government to promote export, acquire hard currency and generate revenue in favor of Chinese exporters. Government protection created price distortions for Chinese manufacturers, and RMB convertibility is art important step to reduce such distortions.

While government protective measures including currency inconvertibility and price distortion were necessary historically in face of powerful foreign competition, China in the past few years has tried its best to remove as many distortions as it can according to IMF requirements for its member countries. Removing more price distortions in China will actually help China increase its export, because the Chinese companies will become more productive and competitive.

China is also changing its strict protection on the capital market through such measures as allowing foreigners to buy B-share stocks directly. Although there are still a lot of restrictions, Larimer comments this is another indication that China is making an effort to remove distortion and protection.

Convertibility Is Overdue

The timing of RMB convertibility is not just appropriate but overdue, says an official of a US agency coordinating trade with China, who declined to be identified. He wishes the measure had been taken 10 years ago, because other steps China took to reform its foreign exchange market have already made it much easier for American investors and corporations to move funds in and out of the country. Whether RMB is convertible or not does not matter so much now; although a free RMB is a welcome step to further promote capital flow.

Until foreign exchange markets were networked in 1994, each foreign company or joint venture was limited to a regional foreign exchange swap market. Before 1994, it caused a lot of headaches for Americans doing business in China. American businessmen trying to exchange large amounts of RMB to US dollars were often told that banks did not have enough, and the delay could be a couple of days to a week.

It is much easier now, because all exchange markets are linked up, and there have been no problems on the swap markets in the last two years. The exchange rate between RMB and the US dollar has been fairly steady, changing from 8.7 in 1994 to 8.3 to the dollar until July 2005. On July 21 2005, RMB devalued again for the first time in a decade to 8.11 US/RMB ratio and also ended the decade long policy of fixed ratio of RMB to US dollars.

Convertibility Is Not the Sole Criterion

RMB convertibility is a complicated issue and is not just designed to let foreigners buy and sell. RMB convertibility "a price and credit reform" involving external and internal convertibility. China exercises a number of internal credit controls, and the challenges created by external convertibility spur the Chinese financial sector to remove internal controls.

China, just like other big countries, has growth imbalances between coastal regions and in-land regions, between urban and rural areas. The government has made efforts to channel resources and mitigate these imbalances. The market will allocate resources more efficiently than government control. An open market will make foreign companies willing to invest in all areas. RMB convertibility is less important than volatility of the exchange rate and liquidity of the foreign exchange market.

RMB convertibility is not the sole criterion for the Chinese importers, either, he adds. Government permits, import quotas and direct import rights also decide whether they will increase or decrease imports.

More American firms would like to use RMB

As RMB becomes convertible, more American firms will use RMB in transactions. Some American exporters are now doing business with Mexico in pesos, which help open the Mexico market. The same will happen in China.

The US-China trade coordinator says many US companies have been using Chinese banks such as the Industrial Bank of China International Trust and Investment Corporation (CITIC) for years and are happy with them. Foreign banks still have a lot of limitations in doing business in China. Western companies still cannot transact business in RMB.

When asked about advice for American exporters, importers and investors, Larimer says simply: "Be patient." He does not expect full convertibility soon. Vadnais says it may take five years for full convertibility to be realized.