The latest stop on the renminbi’s whistle-stop tour to international stardom is Taiwan. From now on, Taiwanese banks will be able to clear transactions in the “redback”, making Taipei another offshore renminbi centre alongside Hong Kong. With Singapore and London jostling to be next and China now firmly established as the world’s second-largest economy, surely it can only be a matter of time before much of the world’s trade is settled in renminbi and central banks are holding a substantial part of their reserves in the Chinese currency?

Not so fast. The “internationalisation of the renminbi” – and never was something so vital for sophisticated dinner-party chatter so hard to pronounce – is as much hype as reality. A look at history is useful. By the time the dollar supplanted sterling as the go-to international currency around 1925, the US had been the world’s biggest economy for more than 40 years. Even then, it took the first world war and massive disruption of European trade to cement its place. True, China’s industrialisation is happening at warp-speed. It is possible that the internationalisation of its currency will move at a similar pace. But there are reasons to doubt that the renminbi is yet ready to join the dollar, or even the euro, as a global currency.

On the surface, progress looks impressive. Since things got started in 2009, offshore renminbi deposits in Hong Kong have leapt from almost nothing to 9.5 per cent of total banking deposits. Trade settlement in renminbi has gone from 2 per cent of Chinese trade in 2010 to 9 per cent in 2011. The issuance of “dim sum bonds”, renminbi-denominated paper issued in Hong Kong, has gathered pace. Caterpillar, McDonald’s and Tesco, plus several banks, including HSBC, are among those to have issued dim sum bonds. At the national level, China has entered into renminbi liquidity swap arrangements with more than a dozen countries from Argentina to New Zealand.

But progress is deceptive. A recent paper* by Yu Yongding, an influential economist at the Chinese Academy of Social Sciences, concludes, “all is not well with yuan internationalisation”. For a start, he says, growth in offshore renminbi use has stalled. Hong Kong deposits held in renminbi actually dropped slightly from Rmb580bn in October 2011 to Rmb554bn in March 2012. Until recently, gambling on renminbi appreciation was a one-way bet. Chinese growth and US pressure on Beijing saw to that. But from last December, the renminbi has moved less predictably against the dollar. This year, it has actually depreciated by about 1 per cent, compared with a 30 per cent appreciation from 2005. Weaker economic prospects in China mean that holding renminbi just for appreciation gains may no longer make sense.

Second, the use of the renminbi as a settlement currency has also slowed. Mr Yu argues that even its use to date is “superficial”, little more than a ruse enabling exchange rate arbitrage between the free offshore renminbi market and the controlled onshore one. If the bulk of renminbi trade is cover for arbitrage, what, asks Mr Yu, is the point?

Arthur Kroeber of Dragonomics, a Beijing-based research boutique, is another sceptic. Today, Dragonomics says, roughly 6 per cent of China’s exports and 13 per cent of imports are invoiced in renminbi. That sounds a lot. Yet by 1990, the same figures for the D-Mark in Germany were 80 per cent and 50 per cent. Even in Japan, which was trying to discourage yen internationalisation because it wanted to control its capital account, they were 38 per cent and 15 per cent. For both, that proved the high point. Today Japan accounts for just 3 per cent of global reserves. The euro makes up 28 per cent of reserves, but Germany had to join a currency union to get there.

The parallels with Japan are instructive. Like Japan, China’s growth model has been built on cheap credit at home and an undervalued currency. Japan only dared to start dismantling capital controls in the early 1980s by which time it had more or less caught up with western living standards. The Communist party is even more dependent on its ability to allocate credit and to protect state-owned industry and job-creating exporters.

That might suggest Beijing has put the cart before the horse. First, it needs to deepen domestic capital markets and free up interest rates so that they respond to market signals rather than telephone calls from state planners. Without such change, opening the capital account would be dangerous. And without that, progress on meaningful internationalisation will be slow.

That begs the question, why launch the process in the first place? One possibility is that Chinese market reformers are hoping that the logic of internationalisation will force change at home. That would make it a form of gaiatsu, the use that Japanese officials have sometimes made of outside pressure to push domestic policy. If that’s the case, it’s possible that internationalisation will proceed apace, with dramatic consequences for China’s domestic capital markets and exchange rate regime. More likely, though, is that Beijing will keep a firm hold and the process will run out of steam.

*Asian Development Bank Institute, Revisiting the Internationalization
of the Yuan, July 2012

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