As RMB rises, more financial reforms needed
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FOREIGN VIEWS
By the end of this year, the IMF will decide whether the Chinese renminbi will join the euro, the Japanese yen, the British pound and the US dollar in the basket of currencies that determines the value of its international reserve asset, the Special Drawing Right (SDR).
China is pushing hard for the renminbi鈥檚 inclusion. Should it be admitted?
The IMF created the SDR in 1969 to supplement existing reserve currencies, thereby providing the global financial system with additional liquidity.
As it stands, the SDR鈥檚 role remains largely limited to IMF operations; its share in global financial markets and central banks鈥 international reserves is negligible. Nonetheless, adding the renminbi to the SDR basket would be symbolically important, implying recognition of China鈥檚 growing global stature.
The renminbi is already a major currency for world trade and investment, and accounts for a growing share of international financial transactions and reserve holdings. To qualify for inclusion, the Chinese government has eased its capital controls and liberalized its financial markets considerably.
Inclusion in the SDR basket would require continuing this process, which, together with the renminbi鈥檚 emergence as a globally investable currency, would benefit the entire world economy.
The IMF鈥檚 largest shareholders 鈥 the US, Europe and Japan 鈥 should thus welcome the renminbi鈥檚 addition to the SDR basket. Yet opinions on the matter have been divided, with the US, in particular, reluctant to welcome China into the fold.
This is all the more problematic given that the 2008 financial crisis laid bare the international reserve system鈥檚 inadequacy when it comes to ensuring sufficient liquidity for emerging economies.
External shocks
Although emerging economies have since accumulated larger foreign-exchange reserves and strengthened financial supervision and regulation, they remain vulnerable to external shocks, especially from the US, the eurozone and Japan. All three have lately employed expansionary monetary policies; and, as the US Federal Reserve normalizes its policy, emerging economies will be hit again by a sudden withdrawal of global liquidity.
This continued vulnerability reflects a collective failure to reform the global monetary system 鈥 an imperative that People鈥檚 Bank of China (PBC) Governor Zhou Xiaochuan highlighted in early 2009. Per Zhou鈥檚 proposal, China has championed a transition to a multi-currency reserve system, in which the SDR and an internationalized renminbi would be used more widely, including in countries鈥 currency reserves.
But its attempt in 2010 to add its currency to the SDR basket failed, because the renminbi was not 鈥渇reely usable.鈥 Since then, China has implemented a series of reforms to increase the renminbi鈥檚 usage in foreign trade and direct investment, as well as in cross-border financial investment. Fourteen renminbi-clearing banks have been established worldwide.
Last year, the Shanghai-Hong Kong Stock Connect was launched to stimulate cross-border investment and capital-market development.
And China has signed bilateral currency-swap agreements with 28 central banks, including the Central Bank of Brazil, the Bank of Canada, the European Central Bank and the Bank of England.
Overtaking the euro
This year, Chinese policymakers have signaled further financial liberalization by removing the domestic cap on banks鈥 deposit rates, thereby giving overseas institutional investors easier access to capital markets.
The PBC is also likely to widen the currency鈥檚 trading band and move toward a more flexible exchange-rate regime.
As a result of these efforts, the renminbi has emerged as the second most used currency in trade finance, overtaking the euro, and the fifth most used for international payments.
Moreover, it is increasingly preferred in currency-market transactions and official foreign-exchange reserves.
If China succeeds in developing a more convertible capital account and bolstering its financial system鈥檚 efficiency, the renminbi is likely to emerge as a new international reserve currency, complementing the US dollar and the euro.
This would benefit companies and central banks alike, by enabling them to diversify their foreign-currency holdings further.
History suggests that a shift in global currency dominance is likely to occur gradually. For now, China is focused on winning the renminbi鈥檚 inclusion, even with a small share, in the SDR currency basket. The IMF鈥檚 major shareholders should seriously consider it.
The renminbi鈥檚 continued internationalization, not to mention further progress on critical financial reforms, would contribute to the creation of a more stable and efficient global reserve system.
Lee Jong-Wha is a professor of economics and director of the Asiatic Research Institute at Korea University. Copyright: Project Syndicate, 2015.www.project-syndicate.org. Shanghai Daily condensed the article.
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