What's Next? by David Hale

Author:David Hale
Language: eng
Format: epub
Publisher: Yale University Press
Published: 2011-06-15T00:00:00+00:00

The RMB as a Potential International Reserve Currency

Turning to consider future possible reserve currencies, what would have to happen for the Chinese RMB to emerge as an international reserve currency?

Viewed in terms of the nine criteria for an international reserve currency, China and the RMB currently meet only five (unit of account, medium of exchange, store of value, economic size, and creditor status), while the remaining four (availability beyond home borders, full convertibility, developed financial system, and network effects) have yet to be met. In terms of its government debt market, China’s government and central bank bond market combined is still relatively small, with approximately $1.4 trillion outstanding in 2008, of which about half (mainly the central bank’s sterilization issuance) was short term. Fiscal policy has generally been conservative, and the debt-to-GDP ratio is low, but the Chinese capital markets, including those for government securities, are still underdeveloped. Liquidity among domestic holders is limited as most purchasers hold until maturity. Foreign exchange controls mean that, other than for tourists’ needs, the RMB is only available on a very limited basis to nonresidents. Access to domestic, onshore RMB equity and debt markets by foreigners or by foreign entities is subject to qualified foreign institutional investors quotas, while onshore RMB deposit accounts at banks are simply not available to nonresidents. Liberalization does not appear to be imminent for the onshore RMB markets. Thus, the RMB does not currently meet the criteria for becoming an international reserve currency.

However, in the offshore arena, the market for RMB has seen some significant developments, and there could be further substantial changes in the next decade. Numerous experiments are currently under way, including bilateral swaps between the Chinese central bank and foreign central banks (one side of which is RMB), and reciprocal invoicing of trade transactions between a number of partner economies and the People’s Republic of China (again involving RMB).

But the main test-bed for gradual liberalization of the RMB is Hong Kong. For several years Hong Kong residents have been able to accumulate RMB deposits (at a limited rate), and since July 2010 several RMB investment products such as RMB-denominated bonds or money market funds have become available in the territory. Also since July 2010 Hong Kong banks have been allowed to offer settlement facilities for trade transactions (but not capital transactions) denominated in RMB, together with limited deposit and lending facilities. For example, loans to companies–whether resident in Hong Kong or not–are permitted if related to trade transactions, but not loans to individuals. These opportunities are important for Hong Kong’s banks, but the overall market in offshore RMB will remain restricted in terms of size and type of transactions permitted. These transactions will not place the RMB in the same league as US dollar transactions in London or Frankfurt where there are no such restrictions.

The gradual internationalization of the RMB must be understood in the broader context of the limited convertibility of the currency. The RMB is convertible only on current account (for trade and

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