20 May 2019
The renminbi could weaken further in the near term, but could regain its footing over the long run. Photo: Reuters
The renminbi could weaken further in the near term, but could regain its footing over the long run. Photo: Reuters

RMB faces a bumpy road amid China ‘trilemma’

The IMF’s decision to include the renminbi in the SDR basket could prompt many Southeast Asian nations to factor in the Chinese currency in their exchange rate moves. In fact, some believe there is already a sign of the so-called “renminbi bloc” in East Asia.

If so, it would mark good progress in renminbi internationalization, given that the region has historically been a “dollar bloc”.

But all said, the Chinese currency still has a long way to go before it can challenge the dominance of the US dollar.

SWIFT’s RMB Tracker shows that the Chinese unit was among the top four world payment currencies by value as of August 2015, overtaking the Japanese yen and reaching a record high share of 2.79 percent in global payments.

In the last three years, the renminbi has overtaken seven currencies, rising from position No. 12 in August 2012 when its share stood at 0.84 percent.

However, the redback fell back to the fifth spot in October 2015. While the Chinese unit moved up rapidly in recent years, it still lags far behind the US dollar, which has a market share of over 40 percent in global payments.

Meanwhile, China has been grappling with massive capital outflow as investors were concerned about the currency’s depreciation. 

The nation’s foreign exchange reserves dropped further by US$87.2 billion to US$3.44 trillion in November, the lowest since February 2013.

There have been reports that forex reserves may have fallen by US$405 billion last year. It’s believed that a substantial chunk of that money was used to safeguard the redback.

Beijing had earlier envisaged that its unit could become a global currency through “one-way appreciation”. But such moves can’t be sustained. The renminbi internationalization has to rely on confidence and demand for the currency in overseas markets. And China has to build a stable, mature, open and market-driven financial market at home.

It seems that Beijing may hold off liberalization of capital account due to the open-economy trilemma. It’s impossible to achieve all three targets for an open economy — a stable foreign exchange rate, free capital movement and an independent monetary policy.

I believe Beijing would opt for independent monetary policy in order to achieve its domestic economic goal. In fact, big nations would put priority on this. And they have to make a difficult decision between stable foreign exchange rate and free capital movement.

In this case, the Chinese currency is set to weaken further if Beijing liberalizes capital control. However, the renminbi may have limited downside room as the central bank won’t tolerate deep currency depreciation and would intervene to stabilize the unit.

China won’t liberalize its capital account until its economy shows signs of recovery and financial reform and restructuring makes progress. Beijing might slow the pace of currency internationalization in the coming year.

The renminbi is set to weaken in the near term given the nation’s slowing economy. However, the unit might regain its strength in the medium and long term. 

Rapid economic growth means rising productivity, as well as higher real wages. That would drive up the real exchange rates, which are nominal rates adjusted for differences in price levels.

The renminbi might face rough weather this year due to flagging economic growth and negative market sentiment. However, it will regain strength in next five to 10 years as China gradually restructures its growth model. By then, there will be a “renminbi bloc” in North and Southeast Asia.

This article appeared in the Hong Kong Economic Journal on Jan. 5.

Translation by Julie Zhu

[Chinese version 中文版]

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Professor, Department of Economics, HKUST Business School; former senior research economist and advisor, Federal Reserve Bank of Dallas

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