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Renminbi: the world's next reserve currency


19 Mar 2014
Qu Hongbin, Co-Head of Asian Economic Research and Chief Economist, Greater China

Qu Hongbin

The 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.

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

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 to 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, plus 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.

China has a three-pronged approach to renminbi internationalisation: expand the currency’s role in foreign trade settlement … encourage its use in
cross-border investment, and develop offshore renminbi centres

Measures include the deregulation of services sectors, simplifying customs clearance and interest rate liberalisation, plus cross-border trade settlement, two-way portfolio investment and allowing 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 Organisation in 2001.

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

Redback rundown

  • 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% of China’s trade is settled in renminbi: in 2010 it was just 3%.
  • China has currency swap agreements with at least 20 central banks.
  • There are now four offshore renminbi centres – Hong Kong, Singapore, London and Taiwan.

This report must be read with the disclosures, analyst certifications and the disclaimer.