beyondbrics

By Nicholas Kwan of Standard Chartered

China’s efforts to develop its currency – the renminbi, or Rmb – into an international reserve currency with controlled convertibility are unprecedented. Its strategy of achieving this through parallel development of the onshore and offshore RMB markets is also unique. Progress in both attempts so far has been remarkable, although it remains a small step in a long journey.

It is a welcome and necessary move, from the perspective of both China and the world.

For China, internationalisation of the Rmb is a critical step towards greater access to global financial markets and resources to support its growth and development – much like China’s entry into the World Trade Organization (WTO) – which has allowed the country to gain much wider access to world markets and to fully integrate with the global trade system.

For the world, an internationalised Rmb not only adds to the list of currencies available to global investors and financiers, but could bring closer integration between China and the world economy, binding its interests more closely to those of other major economies and the global financial system.

Renminbi internationalisation will bring a significant change in the balance of global finance and economic power. If the world’s international reserves were distributed according to the weight of various countries’ GDP in 20 years’ time, the Rmb would probably account for twice as large a share of international reserve holdings as the US dollar, based on our forecast that China’s GDP will be twice as big as that of the US by 2030. This would be a sharp contrast to the current situation, where 60 per cent of global reserves are held in USD and none in Rmb.

By 2030, the renminbi could be one of the most important – if not the most important – currency and asset class in global finance, across FX, debt, equity and derivative markets.

The ultimate destiny of the Rmb may be in less doubt than the path to achieving it, especially given China’s unique strategy of controlled convertibility and parallel market development.

This strategy requires delicate management of the relationship between several issues:

1. capital account convertibility
2. offshore RMB market development
3. internationalisation of the RMB
4. domestic financial reform, especially interest rate deregulation

Theoretically, capital account convertibility can be pursued without an offshore market. In fact, offshore currency markets generally emerge only after a currency is highly convertible and internationalised.

China’s strategy of internationalising its currency through the development of an offshore renminbi market underlines its desire to control the negative impact of increased convertibility on its domestic economy, especially in light of an ill-prepared domestic financial system.

This is no easy task, and is likely to be a bumpy, non-linear path given the complexity of the various systemic reforms required and the large number of vested interests involved.

Yet Beijing’s clear commitment to making the Rmb an international reserve currency, the strong momentum witnessed in the nascent offshore Rmb (or CNH) market in Hong Kong, and the huge benefits China’s full integration with the global financial system would bring to China and the world should generate strong interest and optimism in the ultimate success of this ‘financial integration with Chinese characteristics’.

Nicholas Kwan is Head of Research, Asia at Standard Chartered Bank

Related reading:
A safe approach to convertibility for the renminbi, Joseph Yam’s blog
China’s deficit: bullish for the redback, beyondbrics
Lord Desai: forget the Renminbi, go for the Indian rupee, beyondbrics
Unilever’s dim sum: cheap credit, beyondbrics