The internationalization of the RMB requires a moderate international monetary environment as well as China’s policy effort. A monetary policy coordination could tone down monetary policies and exchange rate swings and would bring about a less volatile and more even international monetary environment. In this article I will explain its logic and a possible process to realize it.
In the global financial crisis of 2008, China faced exchange rate risks in trade and foreign exchange reserves and started settling trade in the RMB as the first step towards RMB internationalization. In March 2009, Zhou Xiaochuan, the governor of the People’s Bank of China (PBOC), pointed out the systemic risks inherent in the international financial system, primarily that it depends on the US dollar — a national currency subject to a national monetary policy — as the international key currency, and proposed a greater role for the International Monetary Fund’s (IMF) special drawing rights (SDR). That he said the SDR basket of currencies should include currencies of all major economies with GDP as the weight, indicated his intention to have the RMB included in the SDR.
A component currency of the SDR is required to be “freely usable.” Although the RMB is not really freely usable, the IMF appreciated the increased international use of the RMB in recent years and decided on its inclusion into the SDR as of October 1, 2016. Christiane Lagarde, the IMF’s managing director, said it was “an important milestone in the integration of the Chinese economy into the global financial system” and expressed her expectation that the Chinese authorities will deepen their efforts to reform China’s financial system. China will need to liberalize its capital account transactions, but this could lead to an increase in cross-border capital flows and destabilize the RMB exchange rates at the expense of China’s stable economic growth.
PBOC governor Zhou Xiaochuan’s response was the “concept of managed convertibility.” China would manage short-term speculative capital flows, while lifting controls on the medium- and long-term capital flows that support the real economy so that “the stable value of the currency and a safe financial environment” could be maintained. However, it was not foolproof. In August 2015, when the PBOC devalued the RMB by 4 percent in order to rectify the overvaluation of the RMB’s effective real exchange rates, it triggered an exodus of hot money of such a magnitude that the PBOC had to intervene in the market, thereby losing a substantial amount of its foreign exchange reserves. This episode indicates that China’s policy efforts alone will not suffice to make the RMB freely usable. A moderate international monetary environment is indispensable as well.
A coordination of monetary policies, designed for the central banks of advanced economies to abstain from excessive quantitative monetary easing, could temper capital flows and exchange rate swings.
It is the liquidity provided by quantitative easing in advanced economies that has moved across borders and destabilized the international monetary environment. A coordination of monetary policies, designed for the central banks of advanced economies to abstain from excessive quantitative monetary easing, could temper capital flows and exchange rate swings. It may sound unrealistic, but there are some influential opinion-makers who support it. The IMF has urged policymakers in all countries, including countries that generate large capital flows, to take into account how their policies may affect global economic and financial stability. The communiques of the G20 finance ministers and central bank governors who met in Shanghai in February 2016 stated that “excess volatility and disorderly movements in exchange rates can have adverse implications for economic and financial stability” and reaffirmed their commitment “not to target the exchange rates for competitive purposes.”
However, the Shanghai communique also stated that “monetary policy will continue to support economic activity and ensure price stability, consistent with central bank’s mandates.” It is these very monetary policies which destabilized the international financial environment by giving rise to large scale cross-border capital flows. If, as is reported, the G20’s working group has studied how to control outflows of capital from emerging economies, this would not solve the problem unless the excess supply of liquidity by quantitative easing is also contained. As Dr. Yu Yongding says, emerging economies have been at the mercy of in-and-out flows of capital caused by the self-centered monetary policies of the advanced economies.
Should the G20 countries agree that quantitative easing has failed to reactivate their economies and that the flows of capital supplied by quantitative easing have destabilized the global financial environment, they could possibly agree on the necessity of coordinating monetary policies. However, the advanced countries are not free from the ideology that a world full of free capital mobility continues to be inevitable and immensely desirable, as Jagdish Bhagawati has put it. Therefore, it is unlikely that they would take the initiative to coordinate their monetary policies. China could and should.
Let it be reminded that, at the outbreak of the global financial crisis in 2008, the G20 Special Summit on Financial Situation was held in Washington DC, obviously because the G7 knew well that it made no sense to discuss what to do without China, the third largest economy at the time. China is now the second largest economy and its voice would carry an even greater weight. China could work with the emerging economies in the G20, India in particular. India is an Asian economic power that is growing fast to follow China. Its central bank governor Raghuram Rajan has said that he would put red lights on “the unconventional monetary policies that lead to small positive effects on exports to emerging economies, a feeble recovery in the source country as well as massive capital outflows and asset price bubbles in the emerging markets.” China and India could make a formidable alliance to make the emerging economies’ case at the coming G20 Hangzhou summit in September 2016. It will be at the coordinators’ meetings prior to the summit where the real talks will take place, reportedly on “more effective and efficient global economic and financial governance”.
Hopefully this will lead to a less volatile and more moderate international financial environment that is friendly for the world’s stable growth, and also for China’s policy effort to make the RMB freely usable. The reform of the international monetary system that Chinese policy makers have been talking about would be a milestone on the road.