1

The internationalization of the RMB: where does the RMB currently process?

A journey to where?

To supervisor: Peggy NG

CHAN YAU LEONG

13616760S

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

2

Integrated Study Report Declaration Form and Word Count.

I, Chan Yau Leong (student no: 13616760s), 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

3

CONTENT

1. INTRODUCTION --------------------------------------------------------------------- P.7-8

1.1 OBJECTIVE-------------------------------------------------------------------P.9

2. DIMENSIONS OF INTERNATIONAL CURRENICES -------------------------P. 10

2.1 USE OF THE RMB FOR OFFICIAL SECTORS-------------------P.11-13

2.2 USE OF THE RMB FOR PRIVATE SECTORS--------------------P.13-17

2.3 COST BENEFIT ANALYSIS IN RMB

INTERNATIONALIZATION--------------------------------------------------P.18

3. THE FUTURES OF RMB INTERNATINLIZATION------------------------------P.19

3.1 DEVELOPMENT OF LIQUID FINANICAL MARKETS------------P.19

3.2 THE FLEXIBILITY OF RMB EXCHANGE RATE-------------------P.20

3.3 CONVERTIBILITY OF THE RMB--------------------------------------P.21

3.4 CAPITAL ACCOUNT LIBERLIZATION-------------------------------P.21

3.5 ROADMAP OF RMB INTERNATIONALIZATION--------------P.22-23

4. CONCLUSION--------------------------------------------------------------------------P. 24

5. REFERENCE -----------------------------------------------------------------------P. 25-27

4

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.13

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

5

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.

6

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 RMB’s 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, 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.

7

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 export–oriented

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 People’s 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: Author’s compilation (2015).

8

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 China’s position in global economics and

financial identity.

In the Chart 2 shows that, in 2012, (M2) China’s money and quasi money reached to

190 percent, which was higher than the Eurozone’s 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) , 1980–2012

Source: World Bank, World Development Indicators database (2013)

9

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.

10

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).

11

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.

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).

12

Since 2008, the People’s 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).

In the China’s 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 world’s official

forex reserves are held in US dollars, while 24% are held in euros. US dollar’s role as

the world’s 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).

13

Chart 3: International reserve currency

Source: IMF statistic department (2012).

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).

14

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).

Chart 4: RMB cross-border trade settlements

Source: HKMA (2013)

Chart 5:

15

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

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

16

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 China’s interbank market. According to the

fund’s reporting, 20.55% of its USD2.1 billion assets (USD431.6m) are invested in

Rmb-denominated instruments showing in Chart 7.

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 currency’s 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, who’s

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%.

17

.However, RMB cannot be deposited in neighboring banking system, which shows

that RMB is still not fully convertible (HKMA, 2012).

Chart 8:

18

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,

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 China’s 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).

19

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

issuer’s 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 PRC’s 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, China’s 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. China’s 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.

20

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).

21

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 China’s

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).

22

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, 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 China’s 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 China’s total trade settled in

23

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.

24

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 China’s 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.

25

5. REFERENCE

HSBC Report. (2014). RMB Internationalization, Capturing the Rise of the Renminbi,

HSBC.

HSBC Report. (2013). RMB Internationalization: RMB going global. HSBC.

Swift Report. (2014). RMB now 5th most traded currency in the world. Swift.

Palmer.N. (2010). China Expands International Use of the Renminbi. China Business

review.

WSJ. (2013). Yuan Passes Euro, Yen to Become Second-Most Used Currency After

Dollar. WSJ.

China Economic Focus. (2014). China Economic Focus – October 2014. British

Embassy Beijing.

Chen. H and Peng W (2007). The Potential of the Renminbi as an International

Currency. China Economic Issues. Hong Kong Monetary Authority.

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www.nationmaster.comInternet Source

www.ieb.esInternet Source

Malovic, Marko. "10.5937/industrija42-6410 =To be or renminbi: Trend in the evolution ofthe international monetary system",Industrija, 2014.Publicat ion

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Publicat ion

Dai, X.. "Who defines the rules of the game inEast Asia? The Trans-Pacif ic Partnership andthe strategic use of international institutions",International Relations of the Asia-Pacif ic,2014.Publicat ion

Heo, Uk, and Wondeuk Cho. "The EconomicCooperation Framework Agreement betweenChina and Taiwan and Its Implications forSouth Korea* : ECFA and Its Implications forSouth Korea", Pacif ic Focus, 2012.Publicat ion

Xiaoli Chen. "Renminbi Going Global", China& World Economy, 03/2011Publicat ion