Will China’s Renminbi Become a Reserve
Currency?
Dr Robert S Gay
Fenwick Advisers
February 15, 2013
The Rationale for Globalization of RMB
China’s Perspective
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China’s trade flows now represent 15% of world total.
As the world’s most populous country and second largest economy, China will
need deeper and more liquid debt markets to finance its transition to domestic-led
growth.
Current model of households subsidizing state banks is not sustainable; negative
deposit rates are a source of popular angst.
Local government subsidies and financing are wasteful and inefficient;
Massive consolidation of industrial sector already is underway; large companies
will need more sophisticated financing options.
Housing price bubble has exacerbated public backlash against income inequality;
mortgage financing is a high social priority that will crowd out corporate lending if
debt capital markets are not expanded.
Financial liberalization is one of the few priorities in the new 5-year plan that does
not involve a major tradeoff between social goals and vested interests.
Serious flaws in euro’s institutional infrastructure and global interbank markets as
well as concerns about Western sovereign indebtedness and Quantitative Easing
has opened the door for another prominent reserve currency.
Goals Versus the Arduous Task of Building
Requisite Financial and Legal Infrastructure
• Dual goal of developing capital markets and globalizing
RMB are intrinsically linked.
• Roadmap to reserve currency status is the same as that to
deeper capital markets.
• IMF’s formal SDR evaluation review (2010) of RMB is such a
roadmap.
• China’s strategy is to introduce deliberate experimental
reforms in local markets and use the experience to broaden
their scope.
China’s Challenges in Making RMB a Reserve
Currency
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Build more liquid financial markets – both local debt instruments and
market for CNY international bonds
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Navigate transition to a more open capital account without opening door
to a financial crisis (asset bubbles, excessive leverage, fraud)
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Manage inevitable slowdown in potential growth and the shift toward
domestic-led growth
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Make legal and enforceable commitments to liquid capital markets,
including strong creditor rights and credible limits to arbitrary use of
executive power to circumvent functioning of capital markets
Creditor rights and open capital markets will take time.
Steps toward Globalization of RMB:
Requisite Attributes of Reserve Currencies
• IMF uses concept of ‘freely usable’ as criterion for including a
currency in SDR basket. To be ‘freely usable’, a currency must be
‘widely used’ and ‘widely traded’
• Measures of ‘widely used’ include: i) currency composition of
official reserves held by CBs; ii) currency denomination of
international debt securities; iii) share of world exports
denominated in a currency
• Measures of ‘widely traded’ include: i) volume of a currency’s
transactions in FX spot markets; ii) existence of forward markets
(deliverable); iii) regular quotes; iv) low transaction costs (bid-ask
spread); iv) volume of turnover in FX derivatives (forwards, swaps,
options) based on market interest rate
‘Official’ Reserves Currencies
(as designated by IMF)
Rank order
Value of ‘official’ reserves
held in: (billions US$)
2012
2001
Percent
• US dollar
$3,580
61.8%
71.1% (of $1,936 bn)
• Euro
1,500
26.0
18.3
• Sterling
238
4.1
2.8
• Japanese yen
220
3.8
6.1
• Swiss franc
6
0.1
0.3
• Other
310
5.3
1.4
Of which new official currencies:
• Aussie dollar
60
1.0
• Canadian dollar
60
1.0
Prospective candidates: Swedish krona, Chinese RMB
---------------------------------------------------US dollars
Total value of reported reserves
$10,500 bn
$1,936 bn
Unreported composition (including China’s)
$ 4,700 billion (mostly China and other Asian nations)
‘Official’ reserves (2012)
$ 5,800 billion
Milestones on the Road to Full CNY
Convertibility
• 2010 SDR valuation review by IMF sets a roadmap for financial
liberalization.
• Authorities first allowed Chinese companies to use RMB in cross-border
trade settlements.
• As foreign companies exporting to China accepted payment in RMB, the
currency accumulated in their Hong Kong bank accounts.
• Next step was to allow foreign firms to tap those funds by issuing RMBdenominated bonds.
• Eligible offshore banks then were permitted to invest RMB funds in China’s
interbank bond market.
• In 2013, China will allow Hong Kong banks to lend RMB to companies in
Shenzhen Province.
• In a clear step toward reserve currency status, China has signed currency
swap agreements with the Philippines, South Korea, Japan and Australia.
• About 10-15 central banks now hold RMB as reserves including Malaysia,
Nigeria, Chile and Peru.
Conclusions
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A realistic expectation is Chinese yuan will become a widely used reserve currency
on a par with sterling or the yen (i.e. 4% of reserve holdings) within the next 10
years.
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The key prerequisite for reserve status is financial reforms including development
of both external and internal debt markets for Yuan-denominated instruments.
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Currency appreciation is likely to proceed hand-in hand with financial liberalization
and adjustment to positive real deposit rates.
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Local markets in turn will require stronger creditor rights and legal safeguards
against arbitrary executive actions in capital market transactions.
For a similar vision of the evolution of reserve currencies, see commentary of Dr Jin,
Head of the Research Institute at The People's Bank of China, in the February
bulletin of the Official Monetary and Financial Institutions Forum at
http://www.omfif.org