RMB internationalization has long way to go

December 12, 2015 08:03
China has made substantial progress in the efforts to take its currency to the global stage, but there is still much that needs to be done. Photo: CNSA

The International Monetary Fund (IMF) announced late last month that China's yuan will be included in the fund's SDR currency basket from October next year. The Chinese unit will join the US dollar, euro, pound sterling and the Japanese yen as the fifth SDR currency. 

The IMF acceptance is undoubtedly a significant milestone in Beijing's efforts to internationalize its currency. However, it does not necessarily mean that it will be a smooth journey for the yuan going forward. The Chinese unit still has a long way to go before it becomes a global currency.

Renminbi internationalization is part of China's long-term strategy to establish a steady global currency market. China hopes its citizens can use the redback for buying or selling goods and services abroad, as well as for borrowing or lending overseas, in order to avoid exchange risks.

More importantly, if China's foreign debt is denominated in renminbi, it can avert currency attacks by speculators when authorities remove capital controls.

Many emerging nations have suffered problems due to speculators' attacks on currencies when the nations were unable to repay their foreign currency debt. The local currency usually weakens sharply during the attack, triggering bankruptcies and bank runs. That leads to massive capital flight and further currency depreciation. That's what we've seen during the 1998 Asian Financial Crisis.

Economics professor Barry Eichengreen of the University of California, Berkeley, used the term "original sin" to describe foreign currency debt as the source of various crises in developing economies.

Now, coming back to China, how can the nation remove its capital account controls and also prevent any currency crisis?

One option is to make the yuan widely used in global trade and finance. It's a key path to get rid of the "original sin". In addition, China could have greater political say in the world, and enjoy seigniorage from other nations. Chinese companies will also be able to obtain low-cost financing from other nations.

The existing international monetary system is dominated by US dollar, which is used as benchmark for pricing, investments and reserves. As a result, many countries have to intervene in the foreign exchange market in order to maintain steady exchange rate against the dollar.

Like other emerging economies, China has pegged yuan to the US dollar since 1980s. And the Chinese central bank bought massive US dollar assets to safeguard the peg. Any dollar weakening will result in huge loss for China.

In order to avert such "dollar trap", China has put forward a "super-sovereign currency" as a global reserve unit. It’s a basket of currencies of world's major economies; the percentage of each currency is determined by the GDP size. SDR basket fits that requirement.

China has to ensure a robust offshore renminbi market if it wants to internationalize its currency.

RMB deposits have risen rapidly in various offshore centers. Renminbi bond and financing market has expanded substantially, while trade settlement in the Chinese currency is also on the rise. Due to all these factors, trading volume of the redback has soared in the forex market.

Nevertheless, our study shows there is large gap between potential and actual use of yuan outside China. In 2013, up to 70 percent of renminbi trade settlement occurred between Hong Kong and China, rather than in outside markets.

The yuan has a long journey ahead in terms of trade invoicing. China should liberalize its capital account and make the renminbi convertible in capital and financial accounts.

Also, Beijing needs to deepen its financial system and allow the offshore currency market to develop to a scale that will help the yuan become a pricing, investment and reserve currency in the Asia Pacific region, and even beyond.

This article appeared in the Hong Kong Economic Journal on Dec. 8.

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