summary_renminbi.txt

Is the Renminbi Ready for Prime Time? hurt Hong Kong, especially if the territory has become highly dependent on renminbi business by then. While using Hong Kong as the main staging ground for the internationalization of the renminbi, the Chinese government is also working to promote competition among financial centers eager to do renminbi business. Regional and international financial centers from Bangkok to Singapore and London to Tokyo are all being baited with small doses of opportunities to engage in renminbi transactions. This competition is useful for Beijing to be able to continue its program of internationalizing the renminbi without the usual prerequisite of opening its capital account and providing more renminbi liquidity. What keeps the various financial centers in Beijing’s thrall is of course the possibility that renminbi business will expand sharply one day when China finally opens its capital account. Every one of these financial centers wants to be well positioned when that day comes. The approach Beijing has taken toward capital account liberalization fits in with the government’s broader objectives. Rather than ceding too much ground to the private sector, the government continues to play an important role in capital outflows, through its sovereign wealth fund, state-owned banks, and state enterprises. Their investments are consistent with China’s broader economic and geopolitical goals, including acquiring advanced technology and increasing the country’s sphere of influence around the world, especially in developing economies. A Slow Move toward the End Game Given its size and economic clout, China is adopting a unique approach to the renminbi’s role in the global monetary system. As with virtually all other major reforms, China is striking out on its own path to a more open capital account. This strategy is likely to involve removing explicit controls while retaining “soft” control over inflows and outflows through administrative measures, such as registration and reporting requirements. Over the next few years, China will have a far more open capital account than it does today but with numerous administrative controls and regulations still in place. This approach will allow the renminbi to play an increasingly significant role in global trade and finance, but in a manner that allows the government to retain some control over capital flows. 259 

Chapter 12 Chinese government to experimentally promote the renminbi’s international use without losing control. Not only could the authorities keep the Mainland financial markets insulated from what was happening in Hong Kong, but they also knew that they could shut things down easily if the reforms created conditions that were causing a loss of control. Meanwhile, its status as an international financial center meant that Hong Kong could actively help build up the renminbi’s role, at least in Asia. China had begun tapping Hong Kong’s potential as a center for promoting the renminbi’s international role many years before. As early as 2004, residents in Hong Kong had been allowed to open deposit accounts denominated in renminbi. In 2007, China began to take additional steps to promote the international use of its currency, in most cases using Hong Kong as the platform. Given China’s rapidly expanding trade volumes, encouraging greater use of the renminbi in trade settlement was a logical step in the currency’s internationalization process. In the relatively short period since its inception in 2009, cross-border trade settlement in the Chinese currency has expanded rapidly. In 2012, trade settlements in renminbi amounted to $465 billion, roughly 11 percent of China’s total trade in goods and services. As with most other data for China, a story hides behind the numbers. Data for these settlement transactions can be analyzed separately for imports and exports. Those data show that, in the first couple of years, most renminbi trade settlement was for transactions that represented imports by China. Payments by Chinese importers in renminbi allow foreign traders to acquire renminbi that are difficult to acquire offshore through other channels. In contrast, there was little settlement in renminbi of China’s exports, suggesting that recipients of exports from China either had limited amounts of the currency or were disinclined to reduce their holdings. One interpretation of this one-sided pattern of trade settlements is that it reflects the desire of foreign traders to bet on the renminbi’s appreciation by acquiring as much of the currency as possible. This is another indication of how China’s rising trade and financial integration with global markets will make it increasingly difficult to tightly manage the currency’s external value. By the latter half of 2012, when appreciation pressures on the renminbi began to ease up, trade settlement in renminbi became more balanced between import and export transactions. 238 

Chapter 12 existing currency mix of United States dollars (USD), the euro (EUR) and the British pound sterling (GBP).” That year, renminbi bonds accounted for about 0.3 percent of its foreign exchange reserve portfolio; U.S. dollar assets accounted for 90 percent of the portfolio. Governor Sanusi Lamido Sanusi said in reference to buying more renminbi assets that “We are looking at anything to start with from 5 to 10 percent of our reserves.” Chile’s central bank had started investing in renminbi assets even earlier, with renminbi assets accounting for about 0.3 percent of its reserves by mid-2011. By the middle of 2012, Banco Central de Chile had decided to invest 2 percent of its investment portfolio in renminbi-denominated instruments. Official statements and news reports suggest that other central banks are also considering adding renminbi assets to their reserve portfolios. An interesting point is that these holdings cannot in principle be regarded as reserves by the IMF, as the renminbi is not a convertible currency. But this does not seem to matter for these central banks, because they view renminbi-denominated assets, just as they do other reserve currency-denominated assets, as providing insurance against balance of payments pressures. Going back to the bazooka principle, the point of reserves is that they should frighten off speculators who want to attack a country’s currency. If part of the bazooka is red-tinged rather than just built of greenbacks, the question is not whether the IMF considers it a legitimate part of the bazooka but what market participants think about it. With China growing and becoming more influential, renminbi reserves may be worth as much as hard currency reserves issued by advanced economies that are in weaker economic shape. Building Bridges to a Rising Power Why are so many countries eager to sign currency swap lines with China and even hold its currency in their reserve portfolios? My contention is that this trend is less a sign of the renminbi’s inevitable march to global dominance than it is a low-cost bet on a likely outcome of a convertible and more widely accepted global currency. Equally important is the desire on the part of many economies to maintain a good economic relationship with China in anticipation of its rising economic power. 248 

Is the Renminbi Ready for Prime Time? In many ways this statement was remarkable—elevating a swap agreement with the PBC to the same status as one among major advanced economy central banks. In June 2013, the Bank of England signed a swap agreement with a maximum value of about $33 billion, making it the first G-7 central bank to sign one with the PBC. Not to be left out, Christian Noyer, the governor of the Banque de France, expressed similar intentions about setting up a currency swap agreement between his institution and the PBC. Proliferating currency swaps are hardly the only way in which the renminbi is becoming a global currency. A Red-Tinged Bazooka In principle, only liquid financial assets denominated in convertible currencies can be counted as part of a country’s foreign exchange reserves. Yet, despite its lack of convertibility, the renminbi is already beginning to appear in a few central banks’ reserve portfolios. Malaysia pioneered this trend in 2010, although the central bank, Bank Negara Malaysia, has never formally declared that it is buying renminbi assets. Other Asian central banks are also looking to renminbi assets as an avenue for diversifying their foreign exchange reserves. In 2012, Bank Indonesia announced that it had started buying bonds on China’s interbank market to help diversify its reserves. The Bank of Korea and Bank of Thailand have also declared their intentions to buy renminbi securities for their reserve portfolios. A few central banks outside Asia are also acquiring renminbi reserves. In November 2011, Austria’s central bank, the Oesterreichische Nationalbank (OeNB), trumpeted its agreement with the PBC that “enables the OeNB to invest via the PBC in Renminbi-denominated assets.” The press release noted proudly that “This is the first agreement of this kind signed by the PBC with a non-Asia central bank, and can be seen as an important step in the good relationship between the PBC and the OeNB.” However, the Austrian central bank had already been beaten to the punch when it came to acquiring renminbi-denominated reserves. The Central Bank of Nigeria issued a statement on September 5, 2011, announcing that it “has finalized arrangements to diversify its external reserves holdings by including the Chinese renminbi (RMB) to [sic] the 247 

Notes to Chapter 12 It is estimated that Hong Kong banks handled about 73 percent of China’s renminbi trade settlement in 2010 and that this proportion rose to 93 percent in the first ten months of 2012. See: “Hong Kong: The Premier Offshore Renminbi Business Center.” Hong Kong Monetary Authority Publications and Research Reference Materials. December 2012. During 2012, remittances of renminbi used for cross-border settlement in Hong Kong averaged roughly $35 billion per month, compared to $9 billion per month in the second half of 2010 (source: CEIC). Cross-border renminbi settlement is not confined exclusively to Hong Kong, but its banks play a dominant role. Renminbi clearing transactions were virtually zero until mid-2010, when financial institutions in Hong Kong were allowed to open renminbi-denominated accounts. Since then, both the volume and value of transactions have increased dramatically. The issuance of dim sum bonds rose sharply from 2007 to 2011 before leveling off at about RMB 110 billion ($18 billion) in 2012, according to the same Hong Kong Monetary Authority report cited above. Some caveats are in order when assessing the renminbi’s rapid growth in offshore transactions. First, dim sum bond issuance remains somewhat narrow in scope, in that such issuance is still heavily confined to banking and financial institutions. Second, a large portion of the issuance currently comes from the Mainland. Third, various reports suggest that a significant portion of cross-border renminbi settlement is used mainly for cross-border arbitrage between Mainland companies and their Hong Kong subsidiaries. These factors imply that the influence of offshore renminbi use still has some ways to go to reach its full potential. See Prasad and Ye (2012) for more discussion and references. Settling Accounts Directly The renminbi-ruble trading is described in: Andrew E. Kramer. “Sidestepping the U.S. Dollar, a Russian Exchange Will Swap Rubles and Renminbi.” New York Times. December 14, 2010. The agreement between the Chinese and Russian central banks can be found in: “China and Russia Signed New Bilateral Local Currency Settlement Agreement.” People’s Bank of China Press Release. June 23, 2011. See Christine Kim. “China, South Korea Agree to Boost Yuan, Won Use in Trade.” Reuters. December 4, 2012. Julia Gillard, the Australian prime minister, announced the initiation of direct currency trading between the Australian dollar and the renminbi in April 2013. See: Josh Noble. “China Opens Aussie Dollar Direct Trading.” Financial Times. April 8, 2013. For details on the China-Japan agreement, see: “Enhanced Cooperation for Financial Markets Development between China and Japan.” People’s Bank of China Press Release. December 25, 2011. China has also given permission for the Japan Bank for International Cooperation to issue a yuan-denominated bond, and Japan has indicated that it will buy some Chinese government bonds, presumably to add to its reserve portfolio. In 2012, Japan’s exports to China were valued at $145 billion and imports at $189 billion. FDI flows between the two countries amounted to $13.6 billion, with 359 

Notes to Chapter 12 A Red-Tinged Bazooka Foreign central banks that want to buy Chinese bonds for their reserve portfolios have to get permission from the Chinese government through the QFII scheme. Sovereign wealth funds have to do the same. By November 2012, the Hong Kong Monetary Authority, Norges Bank, Government of Singapore Investment Corporation, and Temasek Holdings Fullerton Management had reached their $1 billion quotas. Responding to strong demand for higher access limits, in December 2012, SAFE removed the ceiling on inward investments by sovereign wealth funds, central banks, and monetary authorities. See: “Regulations on Foreign Exchange Administration of Domestic Securities Investments by Qualified Foreign Institutional Investors.” SAFE circular. December 2012. After this announcement, Qatar’s sovereign wealth fund was reported to have applied for a QFII license and a $5 billion quota. See: Zhang Dingmin. “China Scraps QFII Limit on Sovereign Funds, Central Banks.” Bloomberg News. December 16, 2012. Bank Negara Malaysia’s renminbi purchases are reported in: Kevin Brown, Robert Cookson, and Goeff Dyer. “Malaysian Bond Boost for Renminbi.” Financial Times. September 19, 2010. Bank Indonesia’s purchases are reported in: Lingling Wei. “Indonesia Joins Yuan Bandwagon.” Wall Street Journal. July 23, 2012. For statements by a Bank of Korea official, see: Song Jung-a and Robert Cookson. “South Korea Seeks to Shift Reserves to China.” Financial Times. May 4, 2011. The Bank of Thailand’s intentions to buy renminbi assets can be found in a speech of Governor Prasarn Trairatvorakul: “Economic and Financial Cooperation between China and Thailand.” Opening remarks at the luncheon to inaugurate the Bank of Thailand Beijing Representative Office, Beijing. April 6, 2012. The Austrian central bank’s announcement is in: “People’s Bank of China and Oesterreichische Nationalbank Sign Important Agreement Today.” Oesterreichische Nationalbank Press Release. November 10, 2011. On Nigeria’s decision to buy renminbi for its reserve portfolio, see: “Nigeria Approves Inclusion of Chinese Renminbi in External Reserves.” Central Bank of Nigeria press release. September 5, 2011. Governor Sanusi’s statement about the extent of planned diversification into renminbi assets is reported in: Tim Cocks. “Nigeria to Put 5–10 Percent of FX Reserves into Yuan.” Reuters. September 5, 2011. Figures for the currency composition of Nigeria’s reserves appear in “Central Bank of Nigeria Annual Report—2011.” Appendix B2. Central Bank of Nigeria. February 2013. The figures for the Chilean central bank’s holdings of renminbi-denominated assets in its investment portfolio are taken from: “Monetary Policy Reports.” Banco Central de Chile. September 2011 (Table B.6) and September 2012 (page 42). Table B.6 in the 2012 report indicates that the share of renminbi assets in the internally managed investment portfolio is 1.64 percent; the text on page 42, which seems to refer to the entire investment portfolio, mentions that the benchmark share is 1.95 percent. For examples of other central banks considering adding renminbi assets to their reserves, see: Vinjeru Mkandawire. “Africa: New Frontier for the Renminbi.” Finan- 363 

Is the Renminbi Ready for Prime Time? Settling trade transactions in renminbi requires access to that currency. To support these transactions, the Hong Kong Interbank Market initiated a renminbi settlement system in March 2006. This system provides services, such as check clearing, remittance processing, and bankcard payment mechanisms. Another major development is the rising issuance of renminbi-denominated bonds, known as dim sum bonds, in Hong Kong. These steps are all gaining traction, although they remain modest in scale. Still, the initiation and rapid expansion of different elements of the offshore renminbi market signal that the currency has gained a foothold in trade and financial transactions in Asia. Settling Accounts Directly China is also taking steps to promote the use of its currency through bilateral agreements with its other major trading partners. In December 2010, the Moscow Interbank Currency Exchange initiated direct trading between the renminbi and the Russian ruble. An exchange for rubles and renminbi was opened in Shanghai at about the same time. In June 2011, the central banks of the two countries signed a formal agreement to promote bilateral local currency settlement. These steps have facilitated settlement of trade transactions between the two countries in their own currencies rather than in dollars. The amounts involved are small so far, but that could change soon. China’s voracious appetite for energy and Russia’s rising energy exports could lead to a rapid expansion of trade and local currency trade settlement between the two countries, bypassing the dollar as the settlement currency. In December 2012, China and South Korea agreed to increase the use of renminbi and Korean won in their bilateral trade. In April 2013, China signed a direct currency agreement with Australia, a major source of its commodity imports. One of these bilateral arrangements that is likely to shape finance in Asia is the pact that China and Japan signed in December 2011 to promote the use of their currencies for bilateral trade and investment flows. Trade between the two economies amounted to about $330 billion in 2012, whereas bilateral financial flows are estimated to be less than $150 billion. Assuming that all these transactions are currently settled in dollars and will eventually be settled in the two countries’ currencies, the effect of switching from dollar-intermediated transactions would still be relatively modest at the global level. Over time, the effects could be larger, as the decline in 239 

Is the Renminbi Ready for Prime Time? • Financial market development: A country must have broad, deep, and liquid financial markets, so that international investors will have access to a wide array of financial assets denominated in its currency. China’s financial markets remain limited and underdeveloped, and they continue to be dominated by a banking system that is hobbled by a number of constraints and inefficiencies. Although China measures up favorably on the first criterion and is making progress on the next three, the last one—financial market development—will ultimately determine winners and losers in the global reserve currency contest. This is the area in which China falls short and is unlikely to catch up to the U.S. and other reserve currency economies in the next few years. Financial development is closely tied to the quality of a country’s public institutions and legal framework, topics that I investigate further in Chapter 15. Notwithstanding its underdeveloped financial markets, China is trying to create a new playbook for its currency. Remarkably, it is making progress in elevating the renminbi to the status of a major player in international finance, despite the lagging economic infrastructure needed to support it in that role. The Renminbi Takes Off The renminbi is already making its presence felt in the intricate dance among reserve currencies, in part as the result of policy actions by the Chinese government. China’s rising economic prowess, especially in international trade, has played a key role. Currency Swaps with China Proliferate Since 2009, the PBC has moved aggressively to establish bilateral swap lines with other central banks to facilitate and expand the use of the renminbi in international trade and financial transactions. In fact, China had established swap lines with many Asian central banks even before it started to actively promote the international use of its currency. Most of these were dollar-renminbi swaps under which China would provide U.S. dollars in exchange for the local currency of the counterparty economy. In other words, the foreign exchange reserves of econo245 

Is the Renminbi Ready for Prime Time? The amounts of the swap lines that many central banks have signed with the PBC are small and by themselves would not provide much protection from a crisis. Initially, these amounts would be helpful only for settling trade transactions. But with an agreement already in place, it would be easier for a central bank to negotiate larger agreements with the PBC and eventually create an additional layer of insurance when the amount grows sufficiently large and the renminbi becomes a reserve currency. Holding even a modest amount of renminbi reserves is a way of buying protection from China, which in turn may be better motivated to provide help to a central bank that has helped the renminbi in its early stages of ascendance. These moves to build bridges to the PBC are all modest in size but symbolically important in signaling the shift in perception about the renminbi’s stability and its future role in the international monetary system. The clamor on the part of so many countries—small and large, within and outside Asia—to develop bilateral financial arrangements with China is striking. Central banks around the world are preparing for a future in which the renminbi will play an increasingly prominent role in international finance. Matchmaking for the Renminbi and Special Drawing Rights On March 23, 2009, Zhou Xiaochuan, the cerebral and understated governor of the PBC, stirred up a hornet’s nest. Frustrated by the lack of progress on monetary reforms despite grand statements by G-20 leaders, he issued a paper on the PBC’s website that would reverberate around the world. The paper was simply entitled “Reform the International Monetary System.” It laid out the case for Special Drawing Rights (SDRs) to play a more prominent role in global finance and coyly hinted that the composition of the SDR needed to keep up with changing times by incorporating the currencies of the major emerging market economies. What is an SDR and what was the fuss about? SDRs constitute an international reserve asset created by the IMF. The SDR exists only on the books of the IMF, and its value is based on a basket of four reserve currencies—the U.S. dollar, the euro, the Japanese yen, and the pound sterling. SDRs are distributed among IMF members on the basis of their 249 

Chapter 12 SDRs currently account for about 3 percent of world official reserve asset holdings, so the direct effect of including the renminbi in the SDR basket would not be substantial. But the symbolic effect would be profound, as even the prospect of the renminbi becoming a part of the SDR basket would encourage central banks around the world to add renminbi assets to their reserve portfolios. Technically, the renminbi cannot become a part of the SDR basket, because it is not a convertible currency. Still, the concept that a freely usable currency ought to qualify for the SDR basket has been thrust into the debate. The argument is that the renminbi already meets the criteria for a freely usable currency, as it is increasingly being used in trade settlement transactions and in the denomination of deposit accounts offshore. The IMF’s position in 2010 was clear and was summarized as follows in a report on its executive board’s discussion of the matter: Directors noted that although China has become the third-largest exporter of goods and services on a five-year average basis and has taken steps to facilitate international use of its currency, the Chinese renminbi does not currently meet the criteria to be a freely usable currency and it would therefore not be included in the SDR basket at this time. Thus, it appeared that the IMF intended to apply the convertibility criterion strictly, which would be logical, because any currency in the SDR basket would presumably automatically be counted as an official reserve currency. With Sarkozy’s encouragement, his compatriot, IMF Managing Director Dominique Strauss-Kahn, used a loophole to change the IMF’s tune. Technically, the SDR basket consists of the four currencies that are issued by IMF members (or monetary unions that include IMF members) that are the largest exporters and that have been determined by the IMF to be freely usable. The latter condition was added as a formal criterion only in 2000 and is clearly open to interpretation. The IMF’s operational definition of a freely usable currency requires that the currency be widely used to make payments for international transactions and widely traded in the principal exchange markets. Thus, the criterion of convertibility is not strictly essential for a currency’s inclusion in the SDR basket. 254