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The internationalization of the RMB: where does the RMB currently process?
A journey to where?
To supervisor: Peggy NG
CHAN YAU LEONG
School of Professional Education and Executive Development (SPEED)
The Hong Kong Polytechnic University
Integrated Study submission for the award of the Bachelor of Arts (Honours) Scheme
in Business (International Business)
Date: 22 April, 2015
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Integrated Study Report Declaration Form and Word Count.
I, Chan Yau Leong, hereby declare that the integrated study report, the title of which
is The internationalization of the RMB: where does the RMB currently process? A
journey to where?, submitted on 24/4 for PolyU SPEED programme (Bachelor of
Arts (Honours) Scheme in Business (International Business), is my work and that, to
the best of my knowledge and belief, it reproduces no material previously published
or written, nor the work of other students, nor material that has been accepted for the
award of any other degree or diploma, except where due acknowledgement has been
made in the text.
Word Count: 3325
Signed by: CY
Date:24/4
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CONTENT
1. INTRODUCTION -------------------------------------------------------------------- P. 7-9
2. DETAILED LITERATURE REVIEW ------------------------------------------P. 10-18
3. RECOMMENDATION AND DISCUSSION, MANAGERIAL IMPLICATIONS -----------------------------------------------------------------------------------------P. 19-23
4. CONCLUSION--------------------------------------------------------------------------P. 24
5. REFERENCE -----------------------------------------------------------------------P. 25-27
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LIST OF CHARTS
CHART 1: THE PROCESS IN RMB INTERNATIONALIZATION ------------------P.7
CHART 2: MONEY AND QUASI MONEY (M2) ---------------------------------------P.8
CHART 3: INTERNATIONAL RESERVE CURRENCY ----------------------------P.12
CHART 4: RMB CROSS-BORDER TRADE SETTLEMENT ----------------------P.14
CHART 5: CHINA-ASEAN TRADE VOLUME --------------------------------------P.14
CHART 6: DIM SUM BONDS ISSUANCE IN HONG KONG --------------------P.15
CHART 7: HEAVY CHINA FOCUS-----------------------------------------------------P.16
CHART 8: RMB DEPOSITS IN HONG KONG ----------------------------------------P.17
CHART 9: FINANICAL SECTOR AND CAPITIAL MARKET --------------------P.20
LSIT OF TABLES
TABLES 1: THE INTERNATIONAL USE OF CURRENCY ------------------------P.10
TABLES 2: BILATERAL CURRENCY SWAP AGREEMENT ----------------------P.11
TABLE 3: THREE STEPS STRATEGY--------------------------------------------------P.22
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ACKNOWLEDEMNTS
I wish to express the deepest appreciation to my supervisor, Dr. Peggy NG, who are
giving the comments and suggestion on how this paper can improve, she has
continually and powerfully conveyed a spirit of an adventure in regard to research and
excitement in regard to teaching. Without her guidance and persistent help this paper
would not have been possible.
I would like to thank my school, PolyU Speed, which provide the best support and
research tools to finish the paper.
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ABSTRACT
The aim of this paper is to examine RMB internationalization current process and
analysis proper measures in the future. Renminbi (RMB) internationalization has been
a living topic in the world, since China has carried out a series of significant reforms
and accelerated promotion of the RMBs position as the international currency in
2009. China has undertaken some practical measures to reach RMB
internationalization such as the Cross-Border Trade RMB Settlement Pilot Project,
Offshore Renminbi (CNH), bilateral currency swap agreements and Dim Sum bonds,
foreign direct investment (FDI) and outward direct investment (ODI). According
to the literature review, we found that although China have done so much measures,
however they should enable RMB to play a more active and constructive role in the
future monetary framework under which multiple currencies will share global
management responsibilities.
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1. INTRODUCTION
Since 1978, China has started reform and opening-up began on a transformational
economics journey with a population of 1.3 billion, and a strong exportoriented
economy.
China has carried out a series of significant reforms and strengthened in its banking
system so as to broaden the financial market. Since the late-2000s, China has started
to internationalize its official currency as Renminbi (RMB).
The starting point in discussion of RMB intemationalization can be dated to March
2009, the governor of the Peoples Bank of China (PBoC, thereafer), Zhou Xiaochuan,
proposed a super-sovereign reserve currency (Zhou, 2009).
Zhou (2009) drew attention to weaknesses of the current international monetary
system, which he argued is too reliant on holding sovereign currency reserves (i.e.,
the U.S. dollar). He urged expanding use of the IMF's Special Drawing Rights and
proposed a stronger international role for the RMB in the valuation of SDR.
It also delivered a strong message to the world: China is dissatisfied with current
international monetary system and eager to change the situation of its over-reliance on
the US dollar. Nevertheless, the Government of China has established dim sum bond
market, offshore RMB product platform, RMB QFII (RQFII) and expanded
Cross-Border Trade RMB Settlement Pilot Project, which can helps establish pools of
offshore RMB liquidity.
Chart 1: The process in RMB internationalization.
Source: Authors compilation (2015).
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Although, RMB has vaulted ahead of the Euro and Japanese yen to become the
second most widely used currency in international-trade finance (WSJ, 2013).
However, RMB still has not consorted with Chinas position in global economics and
financial identity.
In the Chart 2 shows that, in 2012, (M2) Chinas money and quasi money reached to
190 percent, which was higher than the Eurozones 171 percent and the United States
89 percent (World Bank, 2013).
As a result, in contrast to the histories of other major existing international currencies
(US Dollar / USD, Euro, Japanese Yen, UK Pound Sterling), the internationalization
of RMB has proceeded on a starkly different track (Wang, 2013).
Although the RMB is increasing influence all over the world and may finally become
the key of international currency, as of 2014 it was the world's 5th most widely traded
currency (Swift, 2014). Is RMB able to take advantage of the historic opportunity and
become the major currency? There have several important questions remain to be
answered (HSBC, 2014).
Chart 2: Money and quasi money (M2) , 19802012
Source: World Bank, World Development Indicators database (2013)
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1.1 OBJECTIVE OF THE STUDY
This paper using the six major functions in official and private sectors to analysis the
current situation of development of RMB internationalization. Moreover, cost benefit
analysis will be explained in RMB internationalization process. Besides, to provide
comprehensive recommendation for a sustainable process of RMB
internationalization such as and three-step strategy to decide whether RMB is
appropriately rise as international currency or regional currency and predict the
prospect of development of RMB as an international reserve current in the future.
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2. DIMENSIONS OF INTERNATIONAL CURRENICES
The internationalization of a currency means that its can reach beyond national or
regional borders, functioning as three basic functions: medium of exchange, unit of
account and store of value, finally to which becoming an international currency.
Cohen (1971) define as follow: From the perspective of currency functions, an
international currency is one universally accepted and used in global markets, fully or
partially performing the functions of the pricing unit for international settlement,
means of circulation, payment, and reserves.
Based on these definition, according to (Cohen, 1971; Kenen, 1983) stated that an
international currency not only has three basic functions of money, but also can be
further divided into two sub-functions, namely official sectors and private sectors.
In respect of the six major functions, if a currency can perform some of these
functions which can be considered an international currency.
Table 1: The international use of a currency
Source: Cohen (1971).
2.1 USE OF THE RMB FOR OFFICIAL SECTORS
The six functions of RMB, will be explained in official sectors and private sectors to
state the importance of currency functions. The scope and scale of international use of
the RMB is still limited, and is mainly facilitated by official agreements.
In the official sectors, the main way in which the China actively engaged in the East
Asian area currency cooperation and set up a flexible mutual assistance mechanism.
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China took part in bilateral swap agreements with twenty countries, including some
from outside of the region, shown below in Table 2 (Huang and Subacchi, 2012).
Table 2: Bilateral currency swap agreement
Sources: Huang.H and Subacchi.P (2012).
Since 2008, the Peoples Bank of China has signed eight bilateral currency swap
agreement with central bank or monetary authority of South Korea, Malaysia, Belarus
Indonesia, Argentina, Hong Kong, Singapore and Iceland. It is show that the People's
Bank of China using swap agreements is providing the foreign currency to directly
involve in exchange markets and avoid regional financial institutions to driving down
the exchange rate of the domestic currency. So that, the swap agreement is used as
vehicle currency by non-residents (Li, 2011).
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In the Chinas international reserve of other counties is still restrict and little to no exposure in the international markets, because RMB still has not become
well-liquidated (fully convertible) yet, as the Government of China has not taken
responsibilities on economic affairs in global world. Thus, the foreign central bank
have no intention to hold RMB as reserve currency (Jue, 2013).
In December 2006, for the first time, RMB was designated as reserve currency by
foreign central bank, first is the Philippines and then such as Belarus, the Republic of
Korea, Cambodia, Malaysia, Nigeria and the Russian Federation. As a result, its show
that China is have a long distance to achieve as reserve currency (Pasquli ; Bedell,
2013).
Chart 3 indicate the international reserve currency about 61% of the worlds official
forex reserves are held in US dollars, while 24% are held in euros. US dollars role as
the worlds foremost reserve currency. RMB is only 3.1%, its shows that China is still
lack of safe and liquid which is the biggest problem in international reserve progress
(IMF statistic department, 2012).
Chart 3: International reserve currency
Source: IMF statistic department (2012).
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2.2 USE OF THE RMB FOR PRIVATE SECTORS
For the private sectors, the RMB started being used in cross-border trade settlement,
showing in Chart 4, the use of RMB in such transactions has increased strongly, from
RMB 43 million to over RMB 240 million between July 2009 and June 2012 (HKMA,
2013).
Besides, bank loans in HK, bond issuance in HK, equities in domestic market by
qualified foreign institutional investors (QFIIs) and RMB QFIIs (RQFIIs) for Hong
Kong subsidiaries of Mainland Chinese asset management securities brokers,
outbound direct investment (ODI) and interbank bond market for authorized foreign
central banks (HSBC report, 2013).
Furthermore, tourism and international trade promoted RMB circulation and usage in
surrounding countries or regions. In 2004 mainland China signed an agreement with
Hong Kong and Macau, namely the Closer Economic Partnership Arrangement
(CEPA), and in 2010 an agreement with Taiwan, the Economic cooperation
Framework Agreement (ECFA) (Chow, 2013).
As a result, RMB circulation and usage in Hong Kong, Macau, and Taiwan has
reached a significant level. With more trade and large number of tourists, the
circulation of RMB in other neighboring countries or regions has also grown
continuously. Especially in the first half of 2014 which reached US$220.69 billion, an
increase of 4.8 percent compared with the same period in 2013. In the 2014, 400.1
billion have been reached showing in Chart 5 (ASEAN Briefing, 2014).
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Chart 4: RMB cross-border trade settlements
Source: HKMA (2013)
Chart 5:
In the future, China and ASEAN agreed increase two-way trade to US$500 billion by
2015 and US$1 trillion by 2020. They have also agreed to boosting investment,
increasing the use of the RMB as an alternative trading currency among the ASEAN
countries and cooperating to prevent regional financial risk (ASEAN Briefing, 2014).
In respect of the cross-border trade denominated in RMB. In 2007, China has created
dim sum bond market which shows in Chart 6, the bonds is rapid increase using in
Hong Kong between 2007 and 2012, 35.7 billion yuan in dim sum bonds were issued
in 2010 and 131 billion in 2011 (HKMA, 2012), and expanded Cross-Border Trade
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RMB Settlement Pilot Project in 2009, which helps establish pools of offshore RMB
liquidity (Palmer, 2010).
Chart 6:
On 1 July 2010 extended to Mainland Designated Enterprises (MDE) in 12 provinces,
4 autonomous regions and 20 pilot areas including Beijing, Shanghai, trade in the
cross border payment of current account items with any countries. In 2014, RMB
cross-border trade settlement reached RMB 5.9 trillion making a 42 percent increase,
which represent 21 percent of China's trading volume.
In the cross-border investments outside of the QDII/QFII programs, China have
issued the regional bond call Renminibi- denominated bonds. In 2005, Asian bond
fund (ABF2) also allows not only EMEAP members including (China, Korea,
Malaysia, Indonesia, Singapore, the Philippines, Hong Kong and Thailand) but also
available to the public to invest in both Hong Kong and Japan ever granted direct
access (outside the QFII program) to Chinas interbank market. According to the
funds reporting, 20.55% of its USD2.1 billion assets (USD431.6m) are invested in
Rmb-denominated instruments showing in Chart 7.
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Chart 7
Source: ABF-PAIF (2011).
After that, the trade and financial transaction is also an essential function among
private sectors. In 2009, RMB has been accepted as settlement currency in border
trade with neighboring countries such as Laos, Mongolia, North Korea,
Nepal, .Vietnam, resulting in further promoting the currencys use by non-resident. In
Mongolia, 60 percent of the cash in circulation is RMB (Cohen; Chiu, 2014).
Nevertheless, the RMB can be exchanged via unofficial banking, whos
acknowledged by the Government of Vietnam. Furthermore, the RMB is accepted in
shops and restaurants in North Korea. Interestingly, the RMB has become the second
largest exchange currency after the Hong Kong dollar. Official circulation of the
RMB in Cambodia and Nepal are also accepted. In Bank for International Settlements
report trading in the RMB has more than tripled in three years, to $120 billion a day in
2013 (WSJ, 2013).
In Hong Kong, the banking system is accepted RMB deposit-taking, currency
exchange and remittance services. Chart 8 shows the change in RMB deposits in
Hong Kong between 2009 and 2012. Particularly, increasing around 3% to 18%.
.However, RMB cannot be deposited in neighboring banking system, which shows
that RMB is still not fully convertible (HKMA, 2012).
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Chart 8:
2.3 COST BENEFIT ANALYSIS IN RMB INTERNATIONALIZATION
Becoming the internationalization currency which determine economy scale, currency
stability, highly-developed and open financial market, currency inertia (Dong-Huo;
Wang; Shu, 2015). In addition, the cost benefit analysis of RMB, the benefits are
likely exceed the costs, which predict the prospect of development of RMB (Zhang,
2012).
Firstly, in the trade and financial transaction mostly prefer settled in RMB which can
reducing the exchange rate risk for Chinese firms as they begin to invoice and settle
trade in their own currency. Secondly, because China still not fully convertible in
RMB, if RMB internationalization which can improve the funding efficiency of
financial institutions and thus increase international competitiveness. Thirdly, the rise
in cross-border transactions may lead to an effective settlement in bilateral
transactions. After that, it can preserve of the value of its foreign exchange reserve,
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because United States owes China more about $1.2 trillion as dollar denominated debt
in bills, notes and bonds, according to the Treasury about 70 percent of its foreigner
exchange reserves. Last but not least, in the political economy benefits to having an
international currency can promote the international prestige (Murse, 2012).
Against from the benefit, RMB will rise the potential for speculative currency attacks,
and instability in over-monetization and inflexible economy with fragile capital
markets. Also, rising the capital outflows that Chinas M2 ratio have reached 188
percent (see Chart 2) which implies if capital controls have removed and the capital
outflows may be enormous. After that, the financial institutions in China still lack
competitive strength and some protection is needed to the earliest industries (Li,
2013).
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3. THE FUTURES OF RMB INTERNATINLIZATION
From the literature review, China has achieved the remarkable and major progress in
RMB internationalization since 2009. Although RMB could overtake the USD to
become the dominant international currency within a decade. But historical
experience and reality of RMB internationalization will not be a successful progress.
Some argue that the basic condition for international currency which decide the
issuers political and military power, economic size, financial strength, the degree of
financial market development, and history (Frankel, 1999; Michalopoulos, 2006).
Particularly, the international currency requires a liquid financial markets, an
exchange rate flexibility, full convertibility of the currency and capital account
liberalization to guarantee the availability of the international currency.
3.1. DEVELOPMENT OF LIQUID FINANICAL MARKETS
Without reasonably broad, deep, and liquid financial markets, the RMB will not be
creditably used in international transactions and not attractive to international
investors (Cruz; Gao; Song, 2014). The PRCs financial depth as the size of financial
institutions and markets has increased significantly, including Shanghai and Shenzhen
money markets, RMB bond markets, and stock markets.
However, Chinas financial markets are still trivial and superficial because of it is still
allocated by big state-owned commercial banks, and business funding is mainly
provided by bank lending, with bond and equity markets still not mature. Chart 9
shows that comparing with those in developed countries only after the US, Japan and
Eurozone. Chinas financial system is already the fourth largest in the world.
Obviously, in order to improve efficiency and liquidity of financial market, China
have to remove the constraints on participants in its financial markets also prepare
guidance to foreign institutional investors to participate in domestic financial market.
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Chart 9: Financial Sector and Capital Markets
(2013, $ trillion)
Source: People's Republic of China, (2013)
3.2. THE FLEXIBILITY OF RMB EXCHANGE RATE
To become the RMB internationalization, the progressive appreciation is beneficial
not only to releasing the pressure of inflation and economic restricting but also to
long-term sustainable economic stability and growth in China and the world. As a
result, gradually increasing exchange rate flexibility is reasonable. China must adhere
to the principle of progressiveness and make corresponding macroeconomic policies
according to the changing economic environment. While improving the exchange rate
system, it must also consider economic entities tolerance and apply necessary
supporting measures to ensure stable and sustainable long-term economic growth
(Wei, 2014).
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3.3. CONVERTIBILITY OF THE RMB
Today, a currency can be regarded as fully convertible when any holder is free to
convert it at a market rate into one of the major international reserve currencies
(Greene, 1991). Although the current account is under convertible, however the
capital account is still restricted with relative to the assets, securities and short-term
flows. Actually, within the capital account of the cross-border trade settlement provide
greater demand of offshore RMB assets holder to invest in China, it is the small step
of fully convertible RMB. China must be support capital account by facilitating
individual cross-border investment, FDI, on and offshore market.
3.4. CAPITAL ACCOUNT LIBERLIZATION
In the international financial market, China is relative small of the size of economic
and volume of trade, it is because RMB still not freely convertible under the capital
account, also cross-border financial transactions are restricted by capital controls. To
develop capital account liberalization, it is the process of the internationalization of
the RMB.
Actually, its capital account for long term capital has already opened, but the
short-term cross-border capital flows is still in negative contribution to Chinas
economic growth. China must make the RMB exchange rate flexible to reflect
demand for and supply of foreign exchanges in the FX market because of the interest
rate and exchange rate arbitrage are distorting the allocation of resource which is
harmful to economic development (Henry, 2003).
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3.5 ROADMAP OF RMB INTERNATIONALIZATION
Table 3: Three steps strategy
Source: HSBC, (2013)
Generally speaking, the internationalization of a currency requires strong support
from economic strength, a united and stable political environment, a large volume of
international trade, a robust financial market, and stable internal and external asset
valuation.
Looking at the history of the GBP, USD, DEM and JPY, we know that the
internationalization of currency usually takes three stages.
Concerning the functions of RMB, the target for the first step is to promote RMB in
international trade settlement. The target for the second step is to use RMB in
international investment. The target for the last step is to use RMB as one of the
international reserve currencies.
The first step of the Chinas three-step strategy, the trade currency used in neighboring
countries and regions is already well-advanced and achieved. Pilot launch
cross-border trade settlement scheme (see Chart 4. In the Chinas total trade settled in
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RMB has increased from 3 percent in 2010 to 18 percent in 2013. At the end of 2013,
the RMB overtook the Euro as the second trade currency.
The second step as of functions, RMB used for international investment is also well in
progress, used by Offshore RMB market, RMB bond, QFII (see Table 3). RMB is
now become the top ten global payment currencies.
The third step of the RMB as reserve currency which is the least advanced of the three
stages, because of the full RMB convertibility and inside problem such as RMB will
weaken the effectiveness of Chinese monetary policies, reduce the independence of
the domestic economy, and increase exchange rate volatility. These issues will need to
be addressed during the process.
Put simply, the RMB is already a major global currency.
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4. CONCLUSION
RMB will become an international currency and overtake the United States USD by
the mid-2020s.
In the path of the RMB internationalization, it should be a long-term process even
though China is leading trading and second largest economy in the world. Because of
the Chinas financial market is still small and its capital account is not fully opened.
China should advance their financial reform, such as reform the exchange rate and
capital account that can improve and strengthen the liquidity of financial market.
After that, Government of China and People's Bank of China should deregulate and
liberalize capital flows. However, to be consider the current status of RMB and
financial markets in China, a careful progression of internal and external liberalization
is recommended.
Besides, the capital markets needs to become deep, liquid and efficient, which in
reform the exchange rate regime that should be changed to one with a more
market-based approach or increasing the flexibility of the exchange rate. In order to
reform the exchange rate, it should be abolish the capital control in medium-term to
long-term financial assets, and then short-term assets. As a result, it can avoid the
exchange rate too undervalued and rising the overheated domestic economy.
In the future, after speed up its financial reform and capital account liberalization, the
RMB also be pushed on the onshore market. In establishing the Shanghai into
international financial center before 2020, it could be the significant path of RMB
internationalization to be a true global reserve currency accepted by the world for
investment, financing, payment purpose.
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