The growing role of RMB in global reserve currency system
This month, one of the most powerful central banks in the world, the European Central Bank, invested €500 million (US$560 million) of its foreign reserves in renminbi (RMB) assets, by selling a small portion of its US dollar holdings. This is part of the ECB’s diversification strategy to add the Chinese currency into its foreign-exchange reserves decided on January 20.
Over the past few decades China’s reform and opening-up have made its economy conspicuous. In a bid to assure global investors of the investability of the RMB, China has embarked on an ambitious path to internationalize its currency.
Although the ECB’s investment only accounted for 1% of its total €68 billion of foreign-exchange reserves, it marks a big boost for China. It points to growing market confidence in the RMB as a global reserve currency and acceptance of China’s status as a global economic power in Europe. Since being included in the International Monetary Fund’s Special Drawing Rights basket of reference currencies last October, the RMB has been accepted by more and more countries as a reserve currency.
However, that doesn’t mean the RMB will become the dominant reserve currency in lieu of the US dollar or the euro in the near future. In fact, the European Central Bank’s RMB investment is relatively small so far, while the dollar still accounts for most of the ECB’s foreign reserves.
There is still plenty of room for the RMB truly to become a major reserve currency. Its use has accrued to around 2% of global payments, which is not on a par with China’s 10% share of global gross domestic product in recent years. In spite of being the world’s largest trading country, China has settled only 20% of its foreign trade in RMB, much smaller than around 60% settled in euros for the euro zone’s external trade, and 40% in yen for Japanese trade. Instead, it will help create a global multiple reserve currency system in which the US dollar, the euro and the RMB all play their parts.
Nevertheless, the ECB’s feted RMB endorsement should be taken as impetus for Beijing to push ahead with economic and financial-market reforms. China has made headway with greater use of the RMB globally, slowly but steadily, through trade settlement in the currency and RMB-denominated products in offshore market, for example. However, redoubled reforms are needed to remove the main obstacles to capital-market development, including a fragmented regulatory framework, insufficient or inconsistent information disclosure, and meager institutional investors.
Perhaps the full convertibility of the RMB or being a true reserve currency requires further work to be carried out in the following areas.
The first is to maintain economic stability in terms of stable growth, a stable exchange rate and low inflation. China’s increasing share of world trade and the increasing size of its national economy are important to its trading partners, which clearly justify greater use of the RMB. Last November the lingering expectations of further RMB depreciation induced the regulator to tighten controls on money moving out of the country, including closer scrutiny of outbound investments, large overseas money transfers and individual foreign-exchange purchases, which are likely to impede the pace of RMB internationalization.
The second is to deepen capital markets and speed up the integration of onshore and offshore capital markets. Substantial measures have been taken to open up China’s onshore capital markets for foreign investors, for example, a Shanghai-Hong Kong stock-connect program set up to allow overseas investors to short-sell stocks in domestic markets. The offshore market is expanding apace, which allows deeper global RMB liquidity through one of the offshore clearing banks in Hong Kong, Singapore, London, Paris and some countries in the European Union.
Some foreign central banks are allowed to hold RMB in their reserves through channels such as the China Interbank Bond Market scheme and the Qualified Foreign Institutional Investor (QFII) program. This suggests strong interest in and underlying demand for reserve asset diversification into RMB once the onshore market opens up.
In addition, the People’s Bank of China has signed swap agreements with many foreign central banks as credible backstops to make it easier for them to tap a ready source of RMB liquidity to meet the needs of their local markets. While China’s onshore and offshore markets remain separate, there are clear signs of progress toward a single and accessible market.
The third area needing attention is to step up efforts toward a solid and trusted legal and regulatory framework. China has already been using the Shanghai Free Trade Zone (extended to Tianjin and Fujian) to experiment with financial opening and reforms; most of the restrictions that apply to onshore currency trading in China have been lifted in the SFTZ. China has mulled other measures to improve banking-sector stability (for example, deposit insurance), develop a more comprehensive credit-evaluation system, and improve transparency, particularly in areas of monetary policy and foreign exchange.
In sum, the internationalization of the RMB has been an adamant national policy goal for Chinese government, and moving forward at a faster pace than expected. We should expect to see improved industry-side infrastructure, strengthened financial regulations, a well-structured deposit insurance scheme, improved market-driven exit mechanisms for financial institutions, etc.
China’s record of supportive government policies and macroeconomic stability will undoubtedly continue to facilitate the RMB’s internationalization process, with sustained and consistent efforts to help the RMB contribute to the stabilization of the global multiple reserve currency system.
A version of this article was accepted for publication by the Global Times.