According to Dan Steinbock, the internationalisation of the renminbi is accelerating. The inclusion of the yuan in the IMF basket of reserves is now a matter of time.
On August 11, the People’s Bank of China (PBOC) adjusted the exchange-rate of the Chinese renminbi (RMB) against the US dollar to better reflect market conditions. The net effect was a devaluation of 1.9% relative to the dollar.
The adjustment was an effort to comply with the requirements of the International Monetary Fund (IMF) to include the yuan in the reserve currency basket. The move towards a more market-determined rate is what the IMF and the US Treasury, along with European financial authorities, have been asking for.1
It is well-aligned with Beijing’s effort to speed up the RMB internationalisation.
The Renminbi Goes International
Today, China is the world’s biggest exporter and the second-largest economy in the world in absolute terms. At the end of last year, the RMB moved into the fifth position in global payments, but still accounts barely over 2% of the international payments total. However, its explosive potential is reflected by its rise as a settlement currency for China’s global trade to 23% by early 2015.
Until the global financial crisis, the RMB had little exposure to international markets because of government controls that prohibited almost all exports of the currency, or its use in international transactions. In the era of Xi Jinping and Li Keqiang, China is rebalancing toward consumption and innovation, and Beijing is fostering the RMB’s rise in international finance.
After China joined the World Trade Organization (WTO) in 2001 and exports truly took off, the RMB has evolved as an international currency for paying for goods and services. In this era – roughly the 2000s until the global crisis – foreign multinationals invested in China, but Chinese foreign investment was minimal.
In the second stage – the first half of the 2010s – China consolidated its role as the world’s trading engine. As Chinese capital is increasingly going out, leading Chinese brands – from ICT (Lenovo, Huawei, Tencent, Alibaba, China Mobile) to financial institutions (ICBC, China Construction Bank, Agricultural Bank of China, Bank of China) to oil and gas (Sinopec, PetroChina) – are becoming familiar abroad and the RMB’s role is expanding as a currency for global investment.2Concurrently, the number of Chinese traveling overseas has soared to 117 million.
In the third stage, the RMB seeks to achieve a new status as a reserve currency with sovereign governments. That’s where we are today. The transition will not occur without friction. All major international currencies – the US dollar, Euro, British sterling and Japanese yen – have experienced their share of growth pains.
The summer turmoil in the Chinese equity markets reflects these transitional challenges. In early 2013, I predicted the impending boom in the Chinese markets. In mid-June, that boom resulted in a severe correction. Despite volatility, the potential of Chinese market prevails.3
RMB Financial Channels
The internationalisation of the RMB also benefits from the steady expansion of new RMB clearing banks, which provide direct access to RMB liquidity in China, while contributing to the expansion of offshore RMB.
The launch of the Shanghai-Hong Kong Stock Connect – the cross-boundary investment channel that connects the two markets – has boosted the growth of trading volumes, along with Shanghai’s Free Trade Zone (FTZ), which is paving way to new FTZ reforms in other cities.
Despite initial technical challenges and the Chinese stock market correction, the China International Payment System (CIPS) is expected to be introduced in the fall. Scaled down, it will be used only for cross-border yuan trade deals.
There are almost an estimated $500 billion of RMB bilateral currency swaps – agreements between two countries to ensure access to each other’s currency if needed – in China and more than 30 countries.
These efforts are complemented by the launch of the massive “One Belt, One Road” regional initiatives in China’s regional proximity and internationally.
After years of hollow reform pledges by the G7 nations, China is also taking a more proactive role in global finance, through the BRICS New Development Bank and the Asian Infrastructure Investment Bank (AIIB). Despite initial US opposition, the AIIB took off dramatically last spring, especially after the UK joined the bank, which paved the way for other EU economies.4
Emergence of RMB Commodity Trading
Intriguingly, the dominant role of the dollar in global commodity pricing evolved in the 1970s when the US dominance began to erode. When America became an energy importer, it grew more reliant on the leading oil producers. As the Middle East’s oil economies opted for the dollar as payment currency, the petrodollar era came to rest on economic and strategic relations (oil for US dollars and military aid).
Until recently, these arrangements have enhanced US geopolitical might in the Middle East, including Washington’s ties with Saudi Arabia. However, as the US shale revolution took off and China’s role as the largest buyer has steadily increased in the region, the old status quo is gradually eroding.
While the dollar still remains the dominant currency for most commodities, China’s role in international commodity trade has increased dramatically. It is the largest consumer of iron ore, zinc, lead and copper. In the coming years, increasing share of commodity trade is likely to be priced in RMB, as evidenced by the emergence of RMB-denominated contracts on exchanges in Chinese cities.
As the world’s largest consumer and producer of gold, China also hopes to play a role in determining gold prices. Only three years ago, Hong Kong Exchanges and Clearing bought the London Metals Exchange, while Shanghai is about to launch an RMB-denominated gold-index.
In the future, commodity prices are likely to gravitate toward the RMB and other large emerging-economy currencies.5
The $1 Trillion Dollar Reserve-currency Decision
The RMB’s road to a major reserve currency comes with economic and geopolitical challenges. In the past, the value of the currency has caused major debates. These came to an end in May, when the IMF reported that the RMB was fairly valued, while urging Beijing to develop a floating exchange rate within three years.
Nevertheless, US Congress and the Treasury continue to argue that the RMB should be trading at higher levels against the dollar, due to China’s trade surplus, the plunge of oil prices, and rising Chinese productivity. These arguments are no longer persuasive, however.
The fall of the oil prices was triggered by the US shale revolution and the Middle East’s overcapacity. The US has had regional trade deficits for decades with East Asia (first with Japan, then with the Asian tiger economies, and more recently with China). And in the decade prior to recent turmoil, the RMB appreciated 30% against the dollar.
According to China’s central bank, foreign central banks held over $110 billion in RMB-denominated assets in April. Despite rapid RMB expansion, the starting-point is low. In 2014 total foreign exchange reserves amounted to more than $6 trillion.
Today, the RMB fulfills most basic preconditions of a reserve currency. China has become the second-largest economy in the world. Second, the RMB has evolved in an environment of low inflation, small budget deficits and stable growth. Third, the rise of the RMB as major reserve currency relies on strong institutional support. The fourth condition requires deep, open and well-regulated capital markets, which is why China is accelerating financial reforms. In April, Beijing pledged that the capital account liberalisation will occur by the end of the year.
China had hoped the RMB could be added in the IMF’s basket by January 1, 2016. However, in early August, the IMF was asked to delay its RMB inclusion until September 2016. The timing matters. Before the summer, Standard Chartered and AXA Investment Managers estimated that at least $1 trillion of global reserves will switch into Chinese assets when the IMF endorses the RMB as a reserve currency.
Toward Multiple-currency Reserves
In nominal terms, the size of the Chinese economy is likely to exceed that of the US in the 2020s. But size is not everything. While the US economy surpassed that of Britain in the late 19th century, sterling remained the preferred currency in international commerce and the dominant instrument for investments and sovereign reserves well into the early 20th century.
Things began to change after World War I, when the dollar surged in trade finance. As investors began to move from sterling to dollar and central banks started to expand their dollar reserves, the stage was set for a transition.
In the past half a decade, the RMB has achieved dramatic progress in commodities, trade, investment and sovereign reserves. It is increasingly central to commodity trading. The RMB’s catch-up with the Japanese yen and the British pound will take longer – and even longer to gain parity with the dollar and the euro, which still represent 45% and 28% of international payments, respectively.
Nevertheless, the RMB’s role as a major reserve currency is now a matter of time. In the short-term, the transition means increasing market volatility. In the medium-term, it has potential to support China’s rebalancing and thus growth prospects globally.
The RMB will be the first emerging-economy currency that will join the sovereign reserves. In that role, it will pave way to other major emerging-economy currencies in the future.
Dr. Dan Steinbock is an internationally recognized expert of the nascent multipolar world. In addition to advisory activities, he is Research Director of International Business at India China and America Institute (USA) and Visiting Fellow at Shanghai Institutes for International Studies (China) and the EU Center (Singapore). He was born in Europe, resides in the US and spends much time in China and Asia. For more, see www.differencegroup.net
All references are the author’s past commentaries:
1. On the presumed and real reasons behind the RMB adjustment, see “What caused U.S.-Chinese market turmoil?” China-US Focus, August 26, 2015.
2. On the emergence of Chinese foreign direct investment, see “The Rise of the Chinese Multinationals,” The National Interest, Fall 2005 Asia Supplement; “New Innovation Challengers,” The National Interest, Jan-Feb 2007.
3. “The Chinese Market Mystery,” Project Syndicate, Jan. 10, 2013; “China’s $10 Trillion Market Explosion,” Roubini Global/EconoMonitor, June 24, 2015.
4. “The beginning of the AIIB epoch,” China Daily, June 29, 2015.
5. “Fears of impending interest-rate hike tarnish gold,” Shanghai Daily, Aug. 12, 2015.