If China’s economic weight and the size of the economy is taken into consideration, the proportion of the RMB in the international reserve system can indeed be as high as 10% to 12%. But if the openness to international capital markets, the depth of the financial markets, economic freedom and other indicators are also taken into consideration, the RMB can account for only 2% in the international reserve system.
Before a discussion of the RMB’s internationalization, we must first understand what international currency means. It means a certain currency that can play the function of valuation, settlement and reserve value in the international market. Whether the RMB can go abroad and eventually play the role of the major three aspects in the international market, I believe cannot be decided by our subjective wishes alone, but rather determined by the international market. However, what is the basis on which the international market determines this? The final work needs to be done domestically.
The gap between 2% and 12%
What is the position that the RMB currently holds in the international monetary system? IMF releases the proportion of reserve currency in every country every quarter. The data showed that the proportion of the RMB in the international monetary system is now close to zero.
If the figure isn’t taken into consideration, what is the proportion of the RMB in the international reserve system? Some people think because China is the world's second largest economy, the financial scale, international trade and international investment scale is large, so the RMB constitutes 10% to 12% in the international reserves system. However, the research indicates that if different variables are used to explain or predict the proportion of a kind of currency in the international reserve system, the decision index is different. If China’s economic weight and the size of economy are taken into consideration, the proportion of the RMB in the international reserve system can indeed be as high as 10% to 12%. But if the openness to international capital markets, the depth of the financial markets, economic freedom and other indicators are also taken into consideration, the RMB can account for only 2% in the international reserve system.
This suggests that although our economic scale is large enough, the quality is not good enough to overcome the gap of 2% to 12%. What we should do is to improve as we see fit, the realistic proportion of 2% to 12%.
Three things need to be done for the RMB to achieve internationalization
We have carried out a lot of detailed analysis on the process of currency internationalization in the international market, finding that a more effective process of internationalization probably consists of three strategic aspects.
First, the international market must have the opportunity to use the currency. This means that the market is open, and the economic scale is large enough to keep various international trades, so that other countries might use your money. The reason why the RMB is demanded in the international market is that China's trade and investment growth is very fast. For many neighboring countries, China is their most important economic partner. However, I need to emphasize that economic scale is not the most important determinant in the process of currency internationalization. As we all know, the Swiss franc is a very important international currency, but the share of the Swiss economy in the international economy is very little. So it does not mean that if the economic scale of one country is not large, their currency cannot become international currency. Similarly, even though the economic scale is large enough, the currency of the country is not likely to become an international currency. Before World War I, although the size of the U.S. economy had exceeded the sum of the four countries whose economic scales ranks second to fifth in the world, the world's major reserve currency was pounds, not dollars.
Although the economic scale cannot decide whether the currency of one country is internationalized, in order for internationalization of the RMB to go smoothly, sustainable growth of our economy must be maintained. After all, only when the economic scale is increasing and we have more and more communication with other countries on economics, will the demand for the RMB in the international market increase.
Second, allow the foreign organizations and foreign individuals to have the opportunity and they will use the RMB. To achieve this goal, we must open capital accounts, otherwise if someone has RMB currency in hand but doesn’t have the opportunity to use it, the internationalization of the RMB will not occur. Some time ago, an offshore RMB market was carried out in Hong Kong, and we discovered that the demand for the RMB fluctuated. When it appreciated, the RMB was in high demand. When the RMB was devalued, it was in low demand. This indicates that the RMB is considered as a simple value-added product, which is deposited in the bank. This kind of internationalization is not sustainable. We not only hope the RMB is held in hand, but also used for investment opportunities. Whether it is in an onshore or offshore market, financial markets of the RMB should be liberalized.
In the 1980s and 1990s, Japan pushed the internationalization of the yen; the yen's share in the international reserve system had reached 9%, which was the highest. The reason why it declined below 3% is that Japan's capital market is not a very open market, which is a very important aspect. Despite the relatively large size of the Japanese financial market, its liquidity is very low, and they don’t give too many opportunities to foreign investors. Although Japan’s bond market is one of the best in the world, investors will hold it until maturity, and the turnover rate is very low. For investors, there is not only a place to invest with the currency, but also the investments must be easy to quit. Investments that are difficult to get out of are not appealing. So in order to make sure international investors have a place to invest the RMB, capital and financial accounts must be open and the financial market must develop.
Third, two strategies have not progressed far enough for the effective internationalization of the RMB. If we want more people to hold the RMB, we must make them have confidence in our system. The investors that a high-risk country can attract will not be long-term investors. The reason for people to invest in high-risk countries, such as in Africa, is that they seek short-term returns. Why are people willing to put foreign exchange reserves in the U.S.? First, the U.S. market is large and the liquidity is ample; second, we have confidence in the growth potential, innovative capabilities and stability of the system in the United States. In China, we not only want to maintain a sustainable economic scale and open markets, but also more importantly is that our overall system can give confidence to international investors so that they hold onto the currency for a longer time.
How to make international investors have confidence in the RMB? I believe that three aspects can be taken into consideration. First, the monetary policy of the central bank should be transparent, so that international investors believe it to be a predictable and trusted monetary policy. Secondly, there must be a good legal environment, so that people feel comfortable placing their money in our financial markets. Finally, it inevitably involves the reform of the political system of the country. Whether the economy in a country is stable in the long term will definitely be related to the reform of policy, in addition to the support of the economic system.
The RMB is needed, but it doesn’t inspire an optimistic attitude
I think the plan of promoting the internationalization of the RMB has a long way to go. China's economy has maintained a rapid growth, and we can see the RMB is needed around the world, which is not because they are optimistic about China's economy or the RMB, but because after the global financial crisis, people are doubtful about the global international monetary system and the prospects of the dollar. Of course, people's views on the U.S. dollar are also changing. When the financial crisis occurred in 2008, the good old times of the dollar were over and the dollar has gone downhill since then. But looking back, people still put more money in the U.S. market. Why do people put their money in the U.S. market despite the fact that they think the dollar is weaker than it once was? Open our eyes to the whole world, none of the currencies can replace the dollar. In the past, it was hoped that the Euro could replace the dollar, but in the short term, this is not possible.
I think, if the three aspects of the framework mentioned above are achieved, the proportion of the RMB in the international monetary system will increase in the future. But if you ask when the RMB will replace the dollar, or become a major international reserve currency, I think it is quite difficult to predict because it is unlikely to occur in the near future. I'm not saying that the U.S. market is an insurmountable market, but if the RMB becomes a leading international currency, this would be a very important exception in international history. After all, from the current situation, the world's leading international currencies are those of developed countries. If the RMB becomes a major international currency in the next ten or twenty years, it means that since World War II, it is the first time in history for a currency of an emerging market to play a very significant role in the international monetary system.
Is there hope for the RMB to replace the dollar? Of course! But this may be a reform of a relatively long-term process. Currently, the international monetary system and international economic system are changing, which is a new research topic for the whole world.
(Huang Yiping, Vice President of the NSD in Peking University and professor of finance Source: China Economic Weekly)