The Future of the RMB as an International Currency
By Pieter Bottelier
May 3rd, 2011
Since late 2008, in response to the international financial crisis, China has accelerated efforts to promote the RMB as an international currency. An RMB trade settlement pilot scheme was initiated in 2009, although significant progress toward liberalizing the rules governing RMB deposits held outside of China had already been made in Hong Kong. What we don’t know is where these more recent developments will lead.
It would be good for China and good for the world if the RMB became a full-fledged international reserve currency. However, it is at this point not at all clear that China will take all measures necessary to achieve such a major change.
To achieve full convertibility, Beijing would have to remove capital account restrictions and domestic financial controls that help maintain a deliberately repressed financial system and an undervalued exchange rate. Moreover, a freely traded RMB in international markets would inhibit China’s aggressive use of monetary policy to stabilize its economy, an important source of stimulus during the recent financial crisis – at least to the extent that it wants to protect the RMB’s value.
If full-convertibility and dollar-like reserve currency status for the RMB is not China’s immediate goal, what is? At the moment, it appears that China is trying to establish the RMB as a trade settlement currency but not one that is readily convertable into other currencies.
The initial purpose for increasing the use of the RMB through a trade settlement pilot program was to support China’s exporters in the face of sharp trade credit restrictions that intensified the impact of declining world demand during the crisis. However, broader RMB use in international trade transactions could also insulate China from the currency impact of a declining dollar and reduce the rate at which China is accumulating dollar-denominated foreign exchange reserves.
The pilot RMB trade settlement scheme was greatly expanded last year. More than 67,000 exporters in 20 mainland provinces have been licensed to invoice in RMB in all foreign countries.
China frequently engages in market-related policy actions while at the same time seeking specific, and sometimes conflicting, nonmarket outcomes (see previously featured article, “Mao’s Reading and Market Debates”). Paradoxically, at the moment, China’s priority is pushing the RMB out of the mainland (mainly through paying for imports in RMB) rather than inviting RMB into the country as payment for exports.
The reason behind this somewhat perverse turn of events is that China is confronted with the need to reduce its large liquidity overhang from its stimulus-driven lending spree. Running very large trade surpluses works against this goal because RMB payments for exports would return even more RMB to the country. China needs to reduce the excess liquidity that is currently fueling inflation. Ironically, its efforts to expand the use of RMB in export transactions work in the opposite direction.
China is addressing this contradiction by further developing the offshore RMB markets in Hong Kong and elsewhere. These offshore markets would enable China to continue to expand RMB-denominated transactions without bringing the RMB back into the mainland Chinese economy. The countries hosting these markets would assume the foreign exchange risk on their central bank balance sheets — not viewed as much of a risk at this point given that the RMB is expected to appreciate further.
China currently has bilateral currency swap agreements, a precursor to more established markets, that total RMB829.2 billion (about $127 billion at the current exchange rate). China is also reported to be discussing arrangements that would permit economic agents in Brazil and Russia to pay for imports from China in their local currency and vice versa.
The highly regulated Hong Kong-based offshore RMB market has grown so rapidly and in such unorthodox ways that it is difficult for outsiders to stay on top of what is going on. It is clear, however, that multiple, interrelated, but separate offshore and onshore RMB markets are developing. Negotiations between the People’s Bank of China (PBOC) and Singapore’s Monetary Authority to create a second hub for offshore RMB trading are ongoing. After Hong Kong and Singapore, Kuala Lumpur, Jakarta, Manila, Seoul and eventually perhaps even Taipei may be in line to serve as offshore RMB centers in Asia. Outside Asia the offshore RMB is at present hardly traded, but that may also change. Since January 2011, Bank of China (China’s third largest commercial bank by assets) is offering limited RMB deposit services to clients of its branches in London, New York and Canada.
How these events will play out remains uncertain. China may stop short of making the RMB fully convertible and, therefore, usable as a dollar-like international reserve currency. However, that does not exclude the possibility of a more limited role for the RMB as a reserve currency. Malaysia and some smaller Asian countries have already announced that they have or will invest a portion of their foreign exchange reserves in RMB-denominated financial instruments.
In private discussions, senior financial officials in China still maintain that full-convertibility of the RMB remains an ultimate policy objective, but there is no longer an official commitment or a timetable toward such a goal. Yet, these efforts to “internationalize” the RMB are important precursors to full convertibility. Will China abandon its long-standing suspicion of markets and allow market dynamics to determine flows in and out of the country and the exchange rate uncertainty such flows can create? Time will tell.
Washington, D.C., April 29, 2011
 RMB internationalization started (on a small scale) in 2004, when the amount of RMB that mainland visitors to Hong Kong could convert into HK dollars was increased and Hong Kong residents were permitted to open limited RMB accounts with Hong Kong banks.
 In “From greenbacks to ‚Äòredbacks,’” a research paper dated Nov. 9, 2010, HSBC analysts estimate that, prior to the crisis, some 70 percent of China’s exports and imports was invoiced and settled in U.S. dollars and the rest mostly in euro and yen.
Onshore and offshore RMB markets are being kept separate by a complex set of regulations governing the outflow and reflow of RMB. Interest rates and the dollar exchange rate on the onshore and offshore RMB markets can and do diverge. The arrangements are reminiscent of China’s deliberate “dual-track” approach to domestic market reforms in the 1980s and early 1990s. Because China maintains significant capital account restrictions and has a current account surplus, pushing the RMB offshore is not easy. If it had not been for the widespread expectation of further RMB appreciation, it would have been almost impossible under current circumstances.
 Since January 2011, the New York branch of BOC accepts RMB deposits up to $4,000 per day ($20,000 per year) for individual clients and somewhat higher amounts for corporate accounts.