The RMB's long march to internationalisation

China may be the world's second biggest economy, but its currency market share still lags well behind the dollar and the Euro.

Asian Development Bank

Over the past several decades, we have seen how the People’s Republic of China’s (PRC) high economic growth and increasing economic integration with other countries have led to a dramatic increase in the PRC’s clout in global output and trade.

Just look at the facts. The PRC is the world’s second largest economy, accounting for 12 per cent of global gross domestic product in 2013. It is also the world’s largest exporter and second largest importer, accounting for about 12 per cent of world trade in 2013. Attracting more than US$110 billion in foreign direct investment (FDI) in 2013, the PRC is the world’s largest developing country recipient of FDI inflows. It is also the world’s largest holder of FX reserves, with a total of US$3.8 trillion in reserves at the end of 2013.

The PRC may be a globally significant economic and trading power, but the market share of its currency, the renminbi (RMB), lags well behind the US dollar and the euro.

RMB internationalization a gradual approach

To align the RMB with its growing global stature, the PRC has embarked on a strategy to internationalize the RMB. Typically, it is taking a gradual approach. In this, it has embarked on a number of initiatives designed to encourage the wider use of the RMB and raise its status in the international monetary system.

These measures include allowing foreign investors access to domestic capital markets, through programs like the Qualified Foreign Institutional Investor and the RMB Qualified Foreign Institutional Investor. It has also increased flexibility of the exchange rate—the RMB trading band has been widened to /- 2 per cent. Also, through the use of RMB as a settlement currency for cross-border trades, the PRC has been gradually expanding the use of RMB in bilateral trade settlement agreements.

There are other steps being taken, such as the development of RMB deposit accounts and the opening of the offshore RMB market. The PRC has also opened offshore RMB centres, such as in Hong Kong, China; Singapore; and London.

The result has been the emergence of the RMB in the international monetary system. For example, the RMB is beginning to play a role in international trade transactions. In December 2013, the RMB overtook the euro to become the second most used currency in global trade finance after the US dollar. The PRC’s international trade has also grown at a compound annual growth rate of 19 per cent from 2001 to 2013.

RMB bond market getting a boost

The rapid expansion of RMB trade settlement together with other policy and regulatory steps have bolstered the growth of the RMB bond market in Hong Kong, China (also known as the dim sum bond market). From only CNY10 billion in 2007—the year when the first dim sum bond was issued—RMB-denominated bond issuance in Hong Kong, China significantly increased, to CNY372 billion in 2013. In the first 3 months of 2014, bond issuance reached CNY338.8 billion.

The number of bond issuances has likewise climbed steeply from just five in 2007 to 891 in 2012 and 1,160 in 2013, while the number of bond issuers increased from just three in 2007 to 132 in 2013. From January through May 2014, 890 bonds were issued by 107 issuers.

While the bulk of RMB bond issuances originate from companies based in the PRC and Hong Kong, China, issuances from other economies have also grown through the years. In 2010, issuances by firms outside PRC and Hong Kong, China accounted for only CNY5.4 billion. By 2013, their RMB bond issuances amounted to RMB76 billion. As a share of total RMB bond issuance, their share has varied from about 13 per cent to 35 per cent.

Trade settlements have contributed to the rise of the RMB as a global currency. According to SWIFT, the RMB only had a 0.31 per cent share in world currency payments in 2011. In March 2014, however, its share had more than quintupled to 1.62 per cent. The RMB’s ranking in world currency payments has also increased. In October 2011, it was ranked seventeenth in usage but by March 2014, its ranking had shifted to seventh position. Indeed, the RMB is gaining on the Canadian dollar (which held a share of 1.83 per cent, ranking sixth) and the Australian dollar (with a share of 1.84 per cent and fifth in rank).

So while good progress has been made, there is plenty of work to be done. Trade settlements and bond issuance have increased, but from a low base. There have been some relaxation in restrictions on capital flows, but the capital account is still largely controlled. The exchange rate is controlled.

There is a positive trend in RMB as a reserve holding, but it is small compared to other global currencies. Financial markets are not as deep and liquid as those in developed countries, and are much less than those with global currencies. While the accomplishment is impressive, the RMB is far from being a full-fledged international currency.

The PRC is moving in the right direction with these measures and producing positive results. But these developments with the RMB are more a result of the PRC opening up its capital account and deepening its financial markets rather than the pursuit of specific policy goals. All these trends will develop a critical mass over time and have the potential to start transforming the global monetary system.

This article was first published by the Asian Development Bank (www.adb.org). Republished with permission.