What to Know About The Internationalization of the Renminbi

In its quest to become the biggest economy in the world, China has set out to lessen its reliance on the US dollar and position itself as a dominant player in the global economy. By using a combination of incentives and punishments, China has managed to encourage international use of its currency, the renminbi. It has not been an easy feat, but with more and more governments warming up to "the Chinese Yuan" and China's growing global clout, it seems like only a matter of time before the dollar loses its position of power.


The Chinese Reminbi's Quest to Become a World Currency


China is the second-largest economy in the world, but its currency isn't among the most international ones. In fact, it doesn't even rank in the top 10 most traded currencies in the world by weight. According to research conducted by the BIS and the IMF, its share of currency exchange is only around 4.3% – but that may be overly optimistic; they didn't take into account the principle of double-counting since every transaction involves two currencies. The dollar has an 88.3% share, and it remains the world's largest reserve currency.


But China's path to becoming a global currency is long, thanks to its heavily regulated economy. With tight controls on cross-border capital flows and onerous regulations, China has some way to go before it realises its ambitions to become a world currency. Having launched multiple recent initiatives to boost internationalisation, China has nonetheless let its intentions be known. But how successful have these efforts been thus far?


Why Does China Want to Achieve RMB internationalisation?


China's drive to internationalise its currency has multiple benefits. For one thing, it would help the country gain greater economic power, though this is more of a means than an end. China also hopes to benefit from a more stable currency, as its value does not fluctuate as violently as the US dollar does.


In the long term, China could save on its foreign exchange reserves. As the holder of the largest foreign exchange reserves in the world, it supports the global trade system with its stockpile of US dollars. But when the US dollar loses its appeal, the pressure on China's foreign exchange reserves could be alleviated.


China's aim to become a global currency is also an exercise in soft power. It could help the country exert greater influence on international events and implement its policies more efficiently.


Stuck in the Dollar Trap


For international companies, the biggest barrier to doing business with China is the yuan's lack of convertibility. This means that the currency is not freely traded and cannot be converted into other currencies, making it impossible to pay for imports and difficult to repatriate foreign revenue.


As a result, many companies prefer to hold their proceeds in dollars, which is why the trade deficit has widened over the years. In 2017, companies exported over $500 billion in goods to China and imported roughly $350 billion in goods. In 2016, the trade imbalance was even larger, with a $347 billion deficit.


China's economic liberalisation is a slow, painful process. Despite the country's longstanding regulation on capital flows and the ongoing restrictions on international transactions, the government has been making progress.


Extending Beijing's Global Influence


China started to offer incentives to financial institutions and companies in the mid-2000s to boost the international use of its currency. The incentives included lower transaction fees and more favourable interest rates. As a result of these efforts, the use of the renminbi by foreign financial institutions has increased by leaps and bounds. But, China is far from achieving its long-term goals.


The Chinese government, with the Chinese central bank at its helm, has made some headway in its drive to internationalise the renminbi. Its yuan-denominated bond issuances, for example, have seen a great response from international investors. China is also set to increase its share of foreign reserves to 60% by the end of 2016 by replacing the US dollar with the Chinese yuan.


China has also announced plans to create a new Silk Road, a massive trade route that will pass through Eurasia, thereby pitting the Chinese yuan up against the dollar. It has also been reported that China plans to purchase natural gas from central Asia and Russia to help reduce its dependence on the US and Western Europe, and it is using the renminbi to make these transactions.


A Matter of Time?


China's efforts have helped the renminbi become the seventh most used currency for global payments and the second most used currency for global bond issuance. In the first half of this year, the renminbi has seen its share in global trade nearly triple.


However, it is clear that the renminbi is still a long way from being a global currency. China's use of capital controls and its strict regulation still act as a roadblock. China's financial institutions are also not yet prepared to offer the kind of international services that the renminbi requires.


China's efforts towards renminbi internationalisation will take years to bear fruit. The country has to relax its capital controls, reduce the influence of the state in its financial sector and even make English the language of choice for its financial transactions, as well as reduce the yuan's volatility.


The renminbi's rise to becoming a global currency will be a gradual process, but it is certainly not impossible. In a world with rising uncertainties, the "safety" of a currency like the renminbi is something that attracts many countries.


How China Is Pursuing RMB Internationalisation


The Chinese government views the internationalisation of its currency as an important step towards further economic development. China's economy is growing at a breakneck speed, and the Chinese government is keen to ensure that the yuan is recognised as a global currency.


The Chinese government has shown its confidence in its economy and its financial sector by expanding the yuan-denominated bond market. Here are some of the actions that China is undertaking:


1 - Offshore Trading


China started to establish its offshore yuan trading hubs in 2009, with the opening of the first such trading centre in Hong Kong. Since then, the yuan has been included in various international benchmarks and has been made one of the most frequently traded currencies. The number of Hong Kong dollar-yuan trading deals has risen exponentially.


2 - Inclusion in the IMF's SDR basket


In 2015, the IMF decided to include the yuan in its Special Drawing Rights (SDR) basket, one of the currencies that the IMF uses as a reserve asset. The IMF's decision to include the Chinese yuan in the SDR basket has helped to increase its international usage.


3 - RMB-Denominated Bonds


Another step taken by the Chinese government is the issue of RMB-denominated bonds (also known as dim sum bonds) by Chinese companies. The issuance of such bonds is one of the most important steps in creating a new currency's international status. To woo international investors, China has introduced attractive conditions for such bonds. China's bond issuances have attracted a huge amount of international interest, and their popularity is growing.


4 - Foreign Direct Investments


The Chinese government is also focusing on increasing cash outflows from its country to help strengthen the internationalisation of the renminbi. These investments are used to establish Chinese operations in other countries and to purchase local companies. As a result, China is increasingly gaining access to global markets.


5 - Currency Swap Agreements


Another way in which the Chinese government aims to spread the use of its currency is through the setting up of currency swap agreements. These agreements will allow it to swap local currency for another country's currency, allowing it to develop a currency that's more useful. Over the past ten years, China has signed agreements with 36 central banks around the world.


6 - Free trade zones (FTZs)


Another way in which China has been trying to make the renminbi a more widely accepted currency is by setting up free trade zones. Such zones allow for foreign companies to invest in the country and are also expected to generate more investments by Chinese companies in other countries.


Further Actions China May Try to Achieve RMB Internationalisation


1 - Relax Capital Controls


China has very strict capital controls on outflows and inflows. Such controls make it easier for China to manage its economy and implement policies. However, these controls also hamper the internationalisation of the renminbi. China is well aware that its currency needs to be in use more freely around the world if it is to become an accepted global currency.


2 - Open up the Chinese financial sector


Another of China's measures in its efforts to internationalise the renminbi is to open up its financial sector so that it is easier for international banks to set up operations in the country. China is expected to allow foreign banks to open branches in the country in the coming years. Foreign banks can also be permitted to trade in the FX market.


3 - Allow for Greater Currency Convertibility


China is also expected to allow greater convertibility of the renminbi so that it can be used more freely. China will allow the renminbi to be freely traded against other currencies, and the Chinese government will gradually lift restrictions on the use of the renminbi for offshore transactions.


4 - Allow for the Free Flow of Capital


In order to encourage the free flow of capital, China will have to ease its capital controls substantially. However, such an action will be a big step in the right direction and will help in the internationalisation of the renminbi. China could also relax some of its foreign exchange controls to allow investors to make their own investment decisions.


How successful have RMB internationalisation efforts been?


The internationalisation of the renminbi and the yuan remains an important policy for China. Although it has been met with a lot of resistance, the Chinese government has continued to focus on boosting its currency's international usage. In some sectors, the currency is already being used to a large extent.


Some of the sectors in which the use of the Chinese currency has increased include trade, finance and investment. The Chinese government has been making strides in the internationalisation of the currency, but efforts are still not enough. China still has some way to go before it is able to completely internationalise its currency.


Roadblocks to RMB Internationalisation


There are still a number of significant barriers to China's efforts toward the internationalisation of the renminbi. The country has to make a number of changes in order to make its currency globally accepted. Here are some of the main roadblocks that China has to overcome:


1 - Lack of Confidence in the Currency


The biggest reason for the resistance to the use of the renminbi is the lack of confidence in the country and its currency. China will have to undertake a number of measures, such as allowing its currency to freely move around the world and making the Chinese financial sector more transparent, to build this confidence.


2 - China's Capital Controls


China's capital controls remain a major obstacle to the internationalisation of its currency. Such controls restrict the flow of money in and out of the country, thereby making it difficult for the currency to become a global one. China will have to remove some of these controls to allow its currency to become an international one.


3 - The Lack of a Vital Financial Sector


Another problem with the internationalisation of the renminbi is the lack of a vital financial sector. China's financial sector is not ready for the kind of competition that comes with being an international currency. In order to make its currency a global one, China's financial sector will have to become more transparent and free.


Conclusion


China's efforts to internationalise its currency have yielded some results. However, the country still has a long way to go before it can become a global economic leader with a global currency.


China has made substantial progress towards the internationalisation of its currency in recent times, and it is expected to make progress in this regard. Although China's currency will not be accepted worldwide, it will surely make inroads into other countries and will become a more important global currency.


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