A natural corollary of the expansion of China’s economy and its massive financial reform would be the internationalization of the renminbi (RMB). As an international payments currency, the RMB has leapfrogged from 20th position in 2012 to 5th in 2015, accounting for 2.5 percent of global payments as of January 2016. The amount of RMB cross-border trade settlements reached RMB 7.23 trillion in 2015, a 41 percent increase from the previous year since the pilot scheme was introduced in 2009. Starting from October 1, 2016, the Chinese currency will be included in the IMF’s Special Drawing Rights (SDR) basket, marking a milestone in the RMB’s global march and a vote of confidence on China’s ongoing financial reforms.
As China embarks on its One Belt One Road (OBOR) global infrastructure construction initiative, it is likely that the plan will add support to the RMB’s internationalization. The ease of paying Chinese contractors in RMB on OBOR projects and the ease of trading in RMB on OBOR routes will also help the currency to be used more widely overseas. As the RMB is increasingly accepted in international trade, it brings down trade costs with China, facilitates trade settlement, and avoids the risks of using a third-party currency.
China started to forge ahead with its RMB internationalization agenda after the financial crisis in 2008 when its foreign reserves started to lose value rapidly as a result of US quantitative easing. As of now, China has created 17 official RMB clearing centers. Hong Kong remains as the world’s largest RMB clearing center, processing 72.5 percent of all RMB payments. This is followed by the United Kingdom which overtook Singapore in March 2016 to be the world’s second largest RMB offshore clearing center.
Despite the great effort of the Chinese government, the trajectory of the RMB’s internationalization is likely to be moderate, due to a number of factors. First, the sudden divorce between the United Kingdom (UK) and the European Union (EU) could potentially halt the process of RMB internationalization. Trade between China and the EU was worth up to EUR 521 billion (USD 593.43 billion) in 2015 and China was the second biggest goods trading partner to the EU in 2015, after the US. As one of the EU’s core financial centers, the UK risks unravelling EU financial services agreements that have helped turn Britain into Europe’s financial powerhouse with its Brexit choice. Looming uncertainties and weak economic performance amid the crisis could also dampen the UK’s position as the second largest RMB offshore clearing center.
Second, the RMB as a medium of exchange could be affected by China’s modest growth. The economic volatility in China and the world economic slowdown have led to a drop in global trade, which remains as the key factor driving the use of the RMB overseas. While China embraces a “New Normal” of growth, the world does not seem to be optimistic with the slowing down of the huge economy.
Despite the great effort of the Chinese government, the trajectory of RMB’s internationalization is likely to be moderate, due to a number of factors.
Third, market expectations of the RMB’s appreciation or depreciation. As Chinese authorities embrace a more market-based RMB exchange rate, greater currency volatility can be expected, compared to the one-way trend of appreciation in the golden era. Moreover, the RMB is likely to be affected by the US interest rate. Lower US interest rates would require a correspondingly lower RMB interest rate if the desired level of US dollar-renminbi interest rate spreads were to be maintained. Last December, the US Federal Reserve ended a seven-year experiment with near-zero interest rates by raising its benchmark rate. On June 16, 2016, the US Federal Reserve scaled back plans to raise interest rates which permitted more room for China’s interest rate cuts. The change in US interest rate policy could possibly create a depreciation or an appreciation pressure on the RMB, reducing people’s confidence in holding the currency as reserve currency.
Forth, some analysts are particularly concerned about the institutional setting of Chinese financial markets. In order for the RMB to be internationalized and used to finance trade, deep, open, and well-regulated capital and financial markets are necessary to build up confidence. China’s economy has indeed grown dramatically, but its governance remains just as unsophisticated as before. The progress of opening up China’s onshore capital market has been deliberately slow. For the RMB to be a truly global and a more widely held reserve currency, there needs to be greater access for foreign investors into local capital markets, deeper global RMB liquidity, and wider cross-border flow channels.
Another point to consider is for China to schedule a timeline for the announcement of financial policies. Unlike other major powers, China tends to make policy announcements at random times, which could possibly dampen confidence as each sudden announcement creates turbulence in financial and share markets. With a stipulated timeline, markets can cast better expectations and better manage financial disorder.
It will not be an easy transition. Yet, people remain optimistic with regards to China’s economic growth potential and fundamentals. The OBOR, a strategic initiative proposed by the Chinese government to expand land and sea connectivity across three continents, with the objective of promoting trade and economic activities between Asia and Europe, could facilitate the rise of the RMB as an international currency.
It will be a gradual process for China to work on its financial reforms and to fully globalize its currency. While the post-Bretton Woods era is still far from being realized, China can contribute to a multiple reserve currency system in which the US dollar, the euro and the RMB all play their part.