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The momentum to internationalise the renminbi is building up. Wendy Guo and Samuel Lum review the milestones and challenges of renminbi internationalisation.
What does it take to become an international currency?
An international currency is widely held outside the issuing country and used in transactions not just between nationals and non-nationals, but also between non-nationals. It is a unit of account for invoicing trade, denominating financial transactions and currency pegging. It is a medium of exchange for settlement of transactions, for foreign exchange intervention and central bank swaps. It is also a store of value used for currency substitution, cross-border investment and central bank reserves.
What will China gain from internationalising the renminbi?
A challenge facing China’s policymakers is the capital preservation of its vast foreign exchange reserves, of which some 60 per cent are in US dollar-denominated assets. An internationalised renminbi serving as a reserve currency could help China reduce its US dollar exposure.
It could also help China reduce the implicit “seigniorage” charge it pays to the US, given the US dollar’s privileged status as the leading international reserve currency. Other benefits include reducing foreign exchange risk for Chinese businesses and improving funding efficiency of financial institutions.
What are the main impediments to internationalising the renminbi?
The main impediments include inadequate breadth of the Chinese financial system and limited competition among its financial institutions. China’s capital markets to a large degree remain closed to foreign investors given the relatively small size of the Qualified Foreign Institutional Investor (QFII) and related schemes. It appears unlikely that the Chinese government will give up control of its capital account in the foreseeable future. While full currency convertibility and capital account liberalisation are not prerequisites for internationalisation, more liberalisation is needed for progress to be made.
How far is the renminbi along the road to internationalisation?
China has been a significant fund supplier in bilateral swap agreements that use the renminbi as their currency vehicle under the Ching Mai Initiative. This is a multilateral arrangement established in 2000 among the Association of Southeast Asian nations (Asean) Plus Three countries to provide short-term liquidity to member central banks to counter currency speculation and avoid a repeat of the 1997 Asian financial crisis.
In 2004, more than 30 banks in Hong Kong started offering renminbi deposit-taking, remittances and currency exchange services. In 2007, offshore renminbi-denominated bonds, also known as “dimsum” bonds, were first issued in Hong Kong. In the autumn of 2012, renminbi currency futures trading will start in Hong Kong.
Central banks including Malaysia, Nigeria, Chile, Thailand, Brazil and Venezuela, have started to include renminbi in their reserve portfolios. Recently, the quota for the Hong Kong Monetary Authority to invest its reserves in China’s interbank market was doubled. Renminbi internationalisation has progressed to encompass all dimensions from trade invoicing and settlement to investment products to central bank reserves.
What are the challenges and the next steps?
Given the size of China’s economy and international trade, rapid increases in the international use of renminbi in trade invoicing and settlement is almost assured though the volume is still minuscule compared with those of the other main world currencies and fees are still relatively high. However, the renminbi’s allocation in central bank reserve portfolios remains insignificant.
One of the Chinese government’s objectives is building up the service infrastructure and renminbi-denominated investment products offered via offshore renminbi centres. China’s commitment to the development of Hong Kong as a key offshore renminbi centre has been enshrined in China’s 12th Five-Year Plan. Offshore renminbi centres, which include London and Singapore, play a critical role as a “firewall” prior to the full liberalisation of the capital markets, exchange rate and capital account in China.
Longer term, renminbi internationalisation and China’s strategic interest in various Asean countries may strengthen economic ties and could shape a de facto renminbi currency bloc among the Asean and Greater China countries. Optimistic analysts have predicted sizable use of the renminbi in trade globally and full convertibility in about five years.
Wendy Guo is head, education and Samuel Lum is director, private wealth and capital markets at CFA Institute’s Asia Pacific Office