The latest report from SWIFT shows that the share of the RMB in the global payment network dropped to 1.72 percent in June 2016, down 0.18 percent from the figure in May, and is the smallest share for the year to date.1 See Figure 1.
Figure 1. Renminbi Share of SWIFT Transactions (% of Total)
The usage figure in June 2016 is more than 1 percentage point below the record high of 2.79 percent reached in August 2015. The RMB ranked sixth in the list of top currencies for global payments using SWIFT in June 2016. See Figure 2.
Figure 2. Top Currencies for Global Payments (% of Total SWIFT Transactions, June 2016)
The unexpected reversal of the steady expansion of the RMB in the global payment system comes as a big disappointment to many observers. A good number of economists had predicted a steady expansion of the RMB in global usage and there were even pundits who predicted a global payment system in the not too distant future anchored by three currencies — USD, Euro and RMB. Their confidence on the rise of the RMB was anchored on the role of China as the biggest exporting country and the third largest economic bloc of the world. Did anything change in the fundamentals that have hindered the increasing usage of RMB?
It is clear by now that the fundamentals driving the increasing usage of the RMB in global payments have not changed, and what really caused the drop in RMB usage was the expectation of a devaluation of the RMB. After the August 11, 2015 decision on RMB currency reform, the market expectation for RMB depreciation grew and foreign trading partners of China became more willing to pay for Chinese exports in RMB, but were less willing to accept RMB for their exports. A good proof of this conjecture is that foreign related receipts and payments in RMB made by Chinese banks on behalf of clients swung from net outflows of USD 101 billion in 2014, to net inflows of USD 50 billion in 2015. Now with both the Chinese economic growth rate, corporate short term foreign currency debt, and current account surplus stabilizing at a lower but sustainable level, the expectation for RMB depreciation had dropped significantly and it appears that RMB usage in the global payment system will soon reverse its decline and regain the ascendancy path.
To many contrarian economists, the drop in RMB usage is a blessing in disguise. It shutters many conventional thoughts on RMB internationalization and there are indications that Chinese monetary officials have drawn valuable lessons from the episode. These economists hope that a more coherent strategy can take care of both Chinese domestic as well as global economic conditions that will emerge in any future RMB internationalization drive.
Notable lessons from the drop in RMB usage that stemmed from both a fear of RMB depreciation and the revelation of some earlier neglected essential elements of international currencies are:
(1) It is not just the volume of trade that mandates the use of a currency. The pricing power of the trading country is an important factor as well. Empirically, it is observable that the seller of a proprietary product is more likely to enjoy the privilege of invoicing in the home currency while the seller of a commoditized product usually invoices in the vehicle currency that prices the commodity. Even as China is the biggest importer of many commodities, such trade is still denominated in the vehicle currency, the USD. Any move to promote the use of the RMB in trade must take note of the degree of commoditization of Chinese products. The more successful Chinese exports are in the technological ladder and thus becoming more proprietary, the more likely that the RMB will be used in the trade. Promoting RMB internationalization must take export profile and pricing power into account, and the policy on RMB internationalization should not be a central bank decision alone.
(2) The initial modest goal of promoting RMB internationalization by trade channels and keeping the capital account channel closed is not realistic. The huge volume of Chinese imports and exports just makes the system porous and open to arbitrage opportunities by smart traders who shift funds around the current and capital accounts. China has already opened the current account and any RMB internationalization program must include a roadmap of capital account opening.
(3) A capital account opening roadmap is important for a smooth RMB internationalization plan. The Chinese monetary authority should prioritize its policy decision on the capital account before any RMB internationalization program. At the moment, China faces three capital account outflow pressures: Firstly, the individual income tax collection is only 6-7 percent of total government revenue intake. This is very low by international standards and it indirectly indicates the high incidence of individual income tax avoidance. Opening the capital account in the absence of strict individual income tax collection measures will trigger capital flight as China’s highest individual marginal tax rate is 45 percent. Secondly, the Chinese economy is around 14 percent of the global GDP but its savings are almost 30 percent of global savings. With the Chinese economy entering the “new normal” with a lower investment return horizon, the pressure of global asset diversification in search of higher returns for institutional funds will be high once the capital account opens. Thirdly, China is promoting “going out” and “One Belt One Road” to expand its international economic footprint. There will be a corresponding increase in outward investment, and the earlier net capital inflow from Foreign Direct Investment will turned into a negative capital outflow from Overseas Direct Investment (ODI).
(4) Currency value expectation often drives the usage of an international currency, and the RMB usage experience in the last 10 months empirically proves this point. The press conference of People’s Bank of China’s Governor Zhou Xiaochuan and Finance Minister Lou Jiwei in February this year helped a lot in stabilizing the expectation of a RMB depreciation. This empirically important “central bank credibility” issue is often overlooked in Chinese policy circles and has caused a lot of unnecessary market volatility.
(5) Speculators often surface at times of volatility and swing the market to one side. The headline grabbing predictions of Chinese economic collapse by George Soros in January and Kyle Bass in February had hurt the appetite of both financial investors and goods traders to keep the RMB and use it in trade. In contrast to the conviction of efficient market believers, financial markets are often path-dependent, and this is particularly true in the foreign exchange market where so many computerized algorithms that are based on pricing signals rather than economic fundamentals drive the daily trade. How to set up an institutional trading framework to minimize the participation of speculators at normal times and develop strategies to counter speculators at abnormal times remains an issue for Chinese policymakers. In what way should the future RMB internationalization trading mechanism be set up is an important issue in view of the volatility that we had seen in the last twelve months. The conventional approach of feeling the stones as you cross the river is not an optimum policy direction in the financial market. A good financial market policy should be pre-emptive and not reactive.
(6) One of the issues of RMB internationalization is the role of the currency as a reserve currency. We should note that a reserve currency is often slightly overvalued as it provides an incentive for holding the currency. The decline of RMB global usage in the past year demonstrates that nobody wants to hold a depreciating currency. For a country that still counts on foreign trade as a major growth engine, and with its export product composition still not of high value added products, a reserve currency status could be a winner’s curse. In this regard, RMB internationalization should be considered as part of industrial policy as well as currency policy.
(7) The August 2015 RMB depreciation fiasco is often attributed to the market expectation of the capital account opening at that time. Such a market expectation arose because the International Monetary Fund had earlier announced that it will decide on RMB inclusion in the Special Drawing Rights (SDR) basket of currencies by November 2015. There was speculation that China will open the capital market by then or that it will at least announce a time table for the capital account opening to fulfil the SDR “freely usable” inclusion criteria. As the market had noted that the RMB had appreciated a lot in the last ten years on a trade weighted basis, the capital account market opening would be akin to currency depreciation. However, the decision of the IMF to include the RMB in the SDR with a high weighing of 10.92 percent on November 2015 while allowing the capital account control measures to be maintained signifies the international market’s recognition that RMB internationalization can be achieved without capital account opening. The recognition by the IMF that capital account opening is not equal to a country’s currency internationalization is important.2 There is still little work being done on this important economic concept change and China can explore this intellectual foundation change when it designs a new program for RMB internationalization.
(8) An international currency arises from economic factors as well as historical linkages. Empirical data shows that the pound sterling became a global currency due as much to the UK’s colonial empire as well as its industrial power in the 19th century. The USD became the global currency after WWII due also to the US’ hegemonic and economic power. An internationalized currency often has a natural geographic dominance in the real world and China has yet to carve out its natural geographic area of dominance.
Turning a crisis into an opportunity is a famous idiom in Chinese. Many economists vehemently hope that the Chinese government has learnt the lessons well and will design a good RMB internationalization program. It is inevitable that the RMB will play a more important role in the global economy with the increasing share of the Chinese economy in the world. A slow and steadily progressive RMB internationalization program taking both domestic economic policy priorities and the global economic environment into account seems a better choice at the moment, while a mishandled RMB internationalization drive will not only hurt the country, but will hurt all other countries as well.
1. RMB share of SWIFT payments falls back in June. (2016, July 21). Retrieved from http://www.ft.com/fastft/2016/07/21/rmb-share-of-swift-payments-falls-back-in-june/
2. Blanchard, O. (2016, July). Currency wars, coordination, and capital controls. Retrieved from https://piie.com/publications/working-papers/currency-wars-coordination-and-capital-controls