Gradual internationalization of renminbi will benefit world's financial markets, but lessons of others should be heeded.
G20 seminar on reshaping the global monetary system is being held today in the eastern Chinese city of Nanjing. Given growing foreign pressure to appreciate the renminbi, China's forex policy and the renminbi's role in a multi-currency global system are likely be discussed at the meeting.
One week before the meeting, the USD/CNY fixed rate hit its highest point since 2005. Earlier on Jan 4, the World Bank issued its first renminbi-denominated bond. It will raise 500 million ($76 million) from the two-year bond issue with the nominal interest rate of 0.95 percent.
The bond aims to promote the use of the Chinese currency in international markets. The World Bank, as a renowned international financial institution, has supported the development of a Chinese currency market with this offering, as well as raised the significance of the renminbi for international investors. The issue has also enriched the variety of denominated bonds and provided more market liquidity.
At present, most developed international currencies have realized internationalization in varying degrees. Aside from the US dollar, which is the most extensively used currency in international valuation, balance accounts and official reserves, other international currencies include the euro, the Japanese yen and the British pound. Some currencies, like the Austrian dollar, Swiss franc, Canadian dollar, etc, are less influential but still play a role in particular areas.
Looking back, the US dollar, yen and euro had different choices and characteristics when transforming from a national currency into an international one.
In 1944, the Bretton Woods Agreement established the international pegged exchange rate system based on the link between the US dollar and the gold reserve, which became the basic international monetary system.
Under the Marshall Plan, the United States provided non-reimbursable assistance and loans for some European and Asia countries, effectively helping the US dollar become an international currency.
Although the Bretton Woods system crashed in 1970s, the US dollar still plays a significant role in the state credit currency system.
The yen internationalized in a different way. Japan took advantage of being the second largest economy in the world to loan and invest the yen. With Asian countries it strongly recommended using the yen in balance accounts for cross-border trade.
In the late 1980s, the yen became extensively used for trade, direct investment and cross-border loans in Asia. The recent earthquake and tsunami in Japan and the increased volatility of the yen, reflect its importance for global economic and financial stability.
The euro is unique in that it is a currency that surpasses national sovereignty, a radical currency innovation, and the development of the euro was based on the eurozone's large trade volume.
Its share in the global foreign exchange reserve is gradually increasing and its international influence rising. It is estimated that the euro now accounts for 26.5 percent of the world's reserves, up from 17.9 percent in 1999. Since the comprehensive strength of the eurozone is still a little behind the US, the status of the euro is still less than that of the US dollar in the international monetary system.
I think China can learn from the internationalization of the US dollar, the yen and the euro.
The internationalization of the three currencies was closely related to international trade settlements, because trade is the most efficient and direct way for other countries to accept a currency, and trade settlement is a good way to build confidence.
International trade offers a natural advantage for promoting the internationalization of the renminbi.
Moreover, internationalization of the renminbi can start from regionalization. In the internationalization process of the yen and the euro, they both became a regional currency first. Since the financial crisis in the 1990s, Southeast Asian countries have realized the risk of undue dependence on US dollars. The renminbi can gradually undertake the settlements and reserve function in Asia, and then progress to becoming an international currency.
However, we should pay attention to the risks of currency internationalization on the domestic economy and financial market, as well as its impact on the efficiency and autonomy of macro economic policy. Once a currency becomes international, global forces will impact on the currency. Therefore, in the process of internationalizing the renminbi, China should take it step by step, in order to control the risk and ensure policy efficiency.
The renminbi-denominated bond issued by the World Bank indicates that the Chinese currency market is becoming more popular globally. It can be predicted that the renminbi offshore market will develop more rapidly in the future with a more complete role in international valuation, circulation, investment and reserve, with increased market capacity. But we should be aware of the risks that this may bring. For instance, in anticipation of the renminbi's appreciation, there may be a lot of international capital flowing into the Hong Kong market, putting added pressure on the renminbi and cross-border capital regulations.
The offshore market could have a big impact on China's exchange rate and interest rate. Therefore, we should pay attention to increasing competitiveness while controlling the risks in order to promote a healthy financial system.
The author is a researcher with China Foreign Exchange Trade System.
(China Daily 03/31/2011 page8)