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RMB: next reserve currency

Financial reforms are first being tested in the Shanghai free-trade zone

T

he reforms finalised at China’s Third Plenum in November 2013 were the boldest
package of policies seen in decades, indicating the new leaders’ determination to
put the country on a new course. But subsequent concerns about shadow banking,
local-government debt and possible defaults have made policymakers even more

determined to speed up financial reforms.

21 Mar 2014

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As China’s financial reform

continues, we believe the

renminbi will play a much

more prominent role on the

world stage

Redback rundown

Beijing is already freeing up interest rates for foreign-currency deposits, easing
restrictions on cross-border capital flows in the Shanghai free-trade zone and easing
foreign investors’ access to Chinese markets. The daily trading band for the renminbi-
dollar rate has now been doubled to + or -2 per cent.

China has a three-pronged approach to renminbi
internationalisation: expand the currency’s role in foreign trade
settlement – it has already overtaken the euro to become the
second most-used currency in traditional trade finance, after the
dollar – encourage its use in cross-border investment, and develop
offshore renminbi centres.

As a consequence, several foreign central banks now hold renminbi
reserves, suggesting some already see the renminbi as a viable
reserve currency. But becoming a true reserve currency depends
on the size of the home economy, deep and open financial markets

with the currency used for cross-border transactions, supportive government policies and
macroeconomic stability.

The renminbi scores well on all counts. And as China’s financial reform continues, we
believe the renminbi will play a much more prominent role on the world stage. Making the
currency convertible is key, and Beijing has now made it clear that convertibility will be
speeded up.

China is learning from other countries’ mistakes. It opened its current account well before
the capital account, and in a controlled manner. To mitigate the risks of opening the
capital account, reforms will be tested in the Shanghai free-trade zone before being rolled
out nationwide.

Reform measures include the deregulation of services
sectors, the simplification of customs clearance and
liberalisation of interest rates. They have also improved
cross-border trade settlement, and allowed foreign
companies to issue renminbi bonds and access the
domestic equity market.

The Shanghai free-trade zone should prove as significant
for China as the setting up of the Pudong New Area in the
same city in the 1990s, or entry to the World Trade
Organization in 2001.

In light of all this, we now expect full renminbi convertibility
to come earlier than many expect – probably in the next

Bigger deficit should steady China’s growth

19 Mar 2014

China held its growth target at 7.5 per cent but widened its fiscal…

The renminbi is one of the 10 most-
used currencies for payments
worldwide

More than 10,000 financial institutions
do business in renminbi – up from 900
in June 2011

The offshore renminbi bond market –
‘dim sum bonds’ – has doubled each
year since 2008

About 18 per cent of China’s trade is
settled in renminbi: in 2010 it was just 3
per cent

China has currency swap agreements
with at least 20 central banks

There are now four offshore renminbi
centres – Hong Kong, Singapore,
London and Taiwan

two to three years, when last year we projected ‘within five
years’. That will give bigger quotas for overseas investors,
freeing outward direct investment, easing rules on foreign
ownership of banks, and lifting the ceiling on individual
currency purchases.

As renminbi internationalisation and financial reforms
accelerate, the currency’s role in global reserve
management should expand quickly. It will soon be ready
to take its place at the top table. That doesn’t mean the
redback will replace the dollar as the world’s dominant
reserve currency, but it will help create a multiple reserve
currency system in which the dollar, euro and renminbi all
play their part.

The research was first published on 19 March 2014.
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