“Follow the money,” goes the saying. The money that is changing roles of the Renminbi (‘RMB’) and the US dollar, is perhaps the best way to understand the rise of China in a world dominated by the United States.
RMB is a relatively young currency, having first been issued less than 75 years ago. In contrast, the U.S. dollar was first issued in 1785, then centrally by the Federal Reserve in 1913. But the RMB has experienced multiple changes in its management, exchange value, and global importance, especially since the beginning of reform.
The share of China’s renminbi in global reserve portfolios is around 3%, compared to 60% for the US dollar. This article argues that the renminbi can play a more important role in the future, even in the absence of full financial liberalisation.
Aiming to Achieve Global Reserve Status
Achieving reserve currency status isn’t a formal process. Instead, it’s like winning a popularity contest. Before the yuan can become a global currency, it must first be successful as a reserve currency. A reserve currency is one that is held in large amounts by governments and institutions as a supplement to national currencies.
The most popular currency for global trade and cross-border commerce emerges as the de facto reserve currency. The “popularity” of a currency is simply based on the perception of security and resilience of the issuing country. This is the asset or currency that most central banks across the world prefer to hold in reserve, which is why the dominant asset earns the label of ‘reserve currency’.
The process of promoting an international role for the RMB began on a limited, off-Mainland basis in Hong Kong at the end of 2003 and gradually expanded to allow RMB bond sales in 2007. The Chinese government has since the 2008-09 global financial crisis began pushing enthusiastically ahead with renminbi internationalization, with an emphasis mainly on facilitating the use of the renminbi in international trade and developing the offshore renminbi market in Hong Kong. It has for example allowed the use of the renminbi in cross-border trade settlements, established bilateral local currency swap arrangements and allowed the issuance of renminbi-denominated bonds.
In mid-2005, the hard peg to the U.S. dollar was lifted, and what is essentially the current flexible mechanism for the administration of exchange rates was introduced.
On Dec. 1, 2015, the International Monetary Fund (IMF) announced that it awarded the yuan status as a reserve currency. The IMF added the yuan to its Special Drawing Right (SDR) basket on Oct. 1, 2016. This basket currently includes the euro, Japanese yen, British pound, and U.S. dollar.
The RMB’s inclusion was an important milestone in the integration of the Chinese economy into the global financial system have recognised the progress made in reforms to China’s monetary, foreign exchange, and financial systems and acknowledges the advances made in liberalizing, integrating, and improving the infrastructure of its financial markets.
That same year, China established the Asian Infrastructure Investment Bank, which allows it to lend outside the scope of the US-dominated Bretton Woods system, and in tandem with its massive Belt and Road Initiative to build infrastructure.
China’s regulators opened the Mainland to more foreign investment in financial services, expanding bidirectional cross-border capital market opportunities and other wealth management products, pricing key commodities in RMB, and refining exchange rate pricing mechanisms. As a store of value, by the end of 2020 US$271.6 billion worth of RMB was held by 70 central banks across the globe, according to the IMF. This had grown three-fold, from $90 billion four years ago.
Notably, between 13% and 14% of Russia’s foreign exchange holdings are in RMB. Sanctions are reported to be blocking at least half of Russia foreign exchange reserves in gold, U.S. dollars, and euros.
As a medium of exchange, growth has also been dramatic. On 26 Sept. 2022, the People’s Bank of China published the “2022 RMB Internationalization Report”. The report shows that the total amount of cross-border payments and receipts settled in RMB reached a record high. The Report focuses on the international use of RMB, the offshore RMB market, and the prospect of RMB internationalization.
According to the Society for Worldwide Interbank Financial Telecommunications (SWIFT), RMB overtook the Japanese yen to become the fourth global payment currency by value in December 2021, with a share up to 2.7%, which continuously climbed to a historical high point at 3.2% in January 2022.
According to the data on the Currency Composition of Official Foreign Exchange Reserves (COFER) released by the International Monetary Fund (IMF), RMB accounted for 2.88% of global foreign exchange reserves in the first quarter of 2022, up 1.8 percentage points from 2016 when it first entered the IMF’s Special Drawing Rights (SDR) basket, ranking fifth among major reserve currencies.
In May 2022, IMF increased RMB’s share in SDR from 10.92% to 12.28%, reflecting a growing recognition worldwide of the improvement in the free use of RMB.
The Report demonstrates that the amount of cross-border RMB settlements related to the real economy maintain rapid growth. Business areas such as commodities and cross-border e-commerce have become a new pillar of growth, and two-way cross-border investment remains active.
Looks like the world is proceeding towards a multipolar world of key currencies, in which the dollar, euro, and renminbi will coexist. History shows that no single country or economy can remain dominant forever, and that change sometimes comes rapidly. Merchants and investors might opt for a currency because everyone else is using it, but that doesn’t mean the currency’s position is forever secure. After all, narrow spreads in foreign-exchange markets and widely available hedging products have made it much easier than in the past to move from one currency to another.
For the RMB to become a truly global currency, it needs the support of deep, liquid financial markets, which may take decades to develop, even if the Chinese economy continues to grow without interruption. If you had to pick one bank in which to stow your life’s savings for the next 25 years, it wouldn’t be in China.
With the help of import financing, debt payments, payment infrastructures, currency swap lines, and offshore markets, the RMB can still gain a more important role, but it may not displace the dollar as a financial haven. Central banks and sovereign wealth funds will hold RMB if it reduces the volatility of their holdings, but global investors are not likely to rush into Chinese assets during times of crisis.
Contributed by –
DOTO Global Ltd, Mauritius
*The views expressed are personal.