Prospects of Renminbi Internationalization： Benefits， Costs and Challenges

【Abstract】The current global demand for RMB might eventually lead to an internationalization of the currency as China continues to position itself as a leader in the international markets.This paper analyzes the internationalization process；observing current and future measures and possible benefits and costs from an eventual emergence of the RMB as an international currency；while also considering the challenges for the Chinese government， in particular those regarding exchange-rate intervention and access to its capital markets.

【Key words】Monetary Policy；International Finance；Renminbi

1.Prospects of RMB Internationalization

If we take the USD degree of internationalization as 100， the Euro would be nearly 40 and the Japanese Yen 28. For the RMB， it’s only 2. The U.S. dollar and to some extent the Euro are representative of world currencies as nearly 65% of global central bank reserves are held in USD， while approximately 25% in Euros. Almost 60% of international financial transactions are denominated in USD.

The Director of the State Administration of Foreign Exchange and Deputy Governor of the PBOC announced China’s intention to pursue the internationalization of the Renminbi on a market-oriented basis. This is considered by many as a double-edged sword， which can bring potential benefits（e.g.lower transaction costs， increase in foreign capital investment， etc.）butalsocarries latentrisks，suchas lower effectiveness of macroeconomic control tools and an impact on financial markets brought by free capital flows， particularly on the stability of the exchange rate.

2.The Internationalization Process

Firstly， the Chinese government intends to convert the RMB into a regional currency by promoting trade settlements and currency swaps with neighbor economies.Secondly， they aim to promote the use of RMB firstly as an international trade currency，secondlyasaglobal investment currency， and finally， as an international reserve currency.

Some measures undertaken by the PBOC include：

-SettinguptheQualified Foreign Institutional Investors（QFII） program：Foreigners can buy and sell RMB denominated shares in China’s stock exchanges，licensed by CSRC.In December 2011 they implemented the RMB-QFII，which allows Hong Kong subsidiaries to re-invest RMB funds raised in Hong Kong back into China.

-Issuance of Dim Sum （RMB-denominated） bonds：RMB bonds were extended to allow banks to develop all types of RMB products and open participationtoalltypesof financialintermediaries.In2010，Hopewell Highway Infrastructure became the first non-financial entity to issue Dim Sum bonds，followed byMcDonald’s，which was the first foreign and non-financial corporate entity. Later on， the Asian Development Bank issued the first supranational Dim Sum bond.Other foreign MNCs have followed： Tesco raised RMB725million in 2011；Barclays began offering RMB funds in Singapore；Caterpillar issued RMB1billion inNovember 2011；and HSBC has already launched an RMB fixed-income mutual fund in the U.S.

-Currency swap agreements：In2008 thePBOC established a currency swap withSouthKorea，lateronitalsoinked bilateralcurrencyswap agreements withanumberofcountriesthatserveasimportantcommodityandnaturalresource

suppliers，includingtheU.A.E.（RMB35billion），Malaysia（RMB180 billion），Turkey（RMB10billion），Mongolia（RMB 10 billion），and Australia（RMB200 billion）.The RMB was also unpegged from the dollar to referencea basket of foreign currencies on a managed floating exchange rate.

-The RMB cross border trade settlement program between Mainland Designated Enterprises（MDEs）：Allowing firms to conduct trade settlement in Renminbi， it started in 2009 with 5 cities and corporations in Hong Kong，MacauandASEANcountries，with365pilotcompanies and subsequently expanded to over60，000 qualified MDEs. In the latest BRICS conference， Brazil and China established an agreement to settle trade transactions in their own currencies （instead of USD）. For the second quarter of 2011 the amount of trade settled in RMB accounted to almost 600 billion.

-Implementation of the RMB Overseas Direct Investment （ODI）： Allowing Chinese enterprises to conduct ODI in RMB. In April 2011， Hui Xian became the first entity listed on the SEHK with an RMB IPO. The same year the government liberalized cross-border RMB borrowing and lending and relaxed restrictions on currency conversion quotas for individuals in Hong Kong， lifting restrictions blocking the flow of RMB in Hong Kong and allowing anyone in Hong Kong to open RMB accounts.

3.Benefits of RMB as an International Currency

For anyone operating with China， the internationalization will bring more flexibility in payment， collection and potential investments. Foreign traders are now able to open an RMB account in Hong Kong for payment and collection and for cross-border trade settlement in China. The PBOC has estimated that the administrative cost of transacting in USD is 2-3% higher than dealing in local currency due to embedded premiums.

The whole chain for cross-border trade can benefit from this trade settlement initiative： Suppliers can decrease the cost of currency hedging which may result in lower pricing. Concurrently， the whole settlement process is expedited， allowing for a faster payment cycle and lower transaction costs. As for buyers， they will also be able to enjoy reduced administrative costs for making RMB payments. Exporters will also benefit， as the new process will require less interaction with government organizations to complete their trade transactions.

In regards to capital markets， a possible increase in RMB loans and new RMB-denominated investment products are likely to arrive. As regulations open up RMB investment opportunities， companies holding RMB will be able to hedge their risk.

From a global point of view，athird worldcurrencycould be beneficial， especially for Asia，as trade among Asian countries increases. During the last financial crisis，banks in some Asian economies that use USD experienced liquidity issues because of the increased cost of funding.

As for the country’s macroeconomic stability， some authors say that the greater the ability to finance payments deficits with a country’s own money， the easier it is for policy makers to pursue spending objectives.

The most evident advantage of internationalization is international seigniorage. This is generated when foreigners acquire domestic money in exchange for traded goods or services.

4.Implicit Costs of Internationalization

IfChinadoesnotliberalizeitscapitalaccount，Renminbiinternationalizatio

n isunattainable.Thecosts ofincreased domestic financial instability could be substantial. In order to minimize the costs， China should encourage the development of domestic financial markets that are broad and liquid enough to absorb external shocks before proceeding with currency internationalization.

On the other hand， if the Chinese government does not allow a fully free-floating exchange rate， the confidence necessary for the RMB to serve as an international reserve currency is still far from reach. The current confidence in the RMB， sustained by China’s economic growth， is insufficient for the long-term international perspective as a reserve currency.

Furthermore， capital-account surplus and an international currency cannot co-exist. The demand for RMB if it were to become an international reserve currency would be such that the PBOC would have to print and transfer massive amounts of fiat money to supply overseas， which would bring inevitable deficit.

Even if China does not have to give up its current surplus， it will have to give up either its monetary independence or the exchange rate control. A decision by China to internationalize the Renminbi and remove the capital controls would require either letting the Renminbi float freely or giving up independent monetary policy， so that the Chinese interest rates mirror those in the offshore market to prevent arbitrage.

Another possible effect of internationalization is the appreciation of the currency， resulting from increased foreign demand. For consumers this will represent a beneficial increase in their purchasing power， but for producers the competitiveness of their exports will be reduced.

5.Perspectives of Internationalization

The factors that drive demand for a currency can throw light on the prospects of the internationalization process. Firstly， the size and structure of the Chinese economy， particularly the breadth of the trade network and the invoicing structure. Secondly， macroeconomic stability： the currency’s credibility and strength which will make it an attractive store value and foster its demand. Thirdly， the depth and openness of financial markets and currency convertibility.

China has strengths in the first two， but heavy restrictions on capital flow and controls on the exchange rate and convertibility of the currency， represent an obstacle for the internationalization.

6.Final Considerations

In order to achieve currency internationalization China still faces 3 major challenges：

（1）Expanding the supply of RMB-denominated assets in the offshore market， to maintain the momentum of RMB internationalization beyond appreciation expectations.

（2）Greater depth and liberalization of financial markets onshore. In order to reduce risks to the financial sector and to keep pace with the growing offshore market.

（3）Building RMB credibility： Requiring sound economic policies， including stable and low inflation to maintain the value of the currency.

China can benefit from international seigniorage and local firms and individuals can benefit from lower borrowing and transaction costs， but it is the actual political leverage of holding a regional or international currency that will prove the most beneficial. Nonetheless， large amounts of RMB circulating offshore can translate into high volatility for China’s fragile macroeconomic and financial structures. The Chinese government will have to let go with the exchange rate and interest rate manipulations， as they will gradually lose control to the offshore market forces.

【References】

[1]GAO et al.“Internationalisation of the renminbi.”Chinese Academy of Social Sciences（CASS）.

[2]KENEN，PeterB.“Currency internationalization：anoverview.”Princeton University.

[3]SONG et al.“Opportunities and Challenges of Renminbi Internationalization.”Renmin University of China.2nd International Conference on Social Science and Humanity，IPEDR vol.31，2012.

[4]SWIFT.“RMB internationalisation： Implications for the global financial industry.”White Paper.Available at：http：//www.swift.com.

[5]YU，Yongding.“Revisiting the Internationalization of the Yuan.”ADBI Working Paper Series No.366，Asian Development Bank Institute，July，2012.