Since the eruption of the Great Financial Crisis (GFC), the world has tried almost every means to prevent future crisis and reinvigorate the world economy. At the global economic governance level, the G20 Summit was established as the premium forum of international economy, where the leaders of the largest 20 economies sit together, talk about the world economic problems and give political instructions to the international economic institutions. As a result, the IMF, World Bank and FSF got their biggest reform in history. At the regional/trans-regional level, there are many initiatives for crisis prevention and economic growth promotion, e.g., the TPP pushed aggressively by the US, the Regional Comprehensive Economic Partnership (RCEP) and CMIM in East Asia. At the national level, almost all major economies have taken numerous policy measures to rebalance and maintain their economic momentum. But one phenomenon is particularly distinguished from all other stimulating and crisis prevention measures, the RMB internationalization strategy adopted by China. Looking across the globe, in the shadow of the GFC, only China, the very single country, takes its currency as a real sense tool to not only counter the negative effects of the crisis but also to consolidate the basis for its even greater economic success in the future. Why does China decide to promote the internationalization of RMB? Is China ready to have the RMB as an international currency? How does China implement the strategy? What will be the impact if the strategy gets successful? This paper tries to provide some personal observations.

I. Why China Chooses RMB Internationalization

As we know, being an international currency will not only bring the issuing country many benefits but also many restraints. For this reason, even inside China, there are many diversified views in terms of RMB internationalization, some strongly advocate, others think it childish. Nevertheless, the Chinese government seems finally determined to promote the process. Many symbols show that, in large part, the government was forced to do that rather than it had an ambitious strategy at the beginning.

Foremost, China’s RMB internationalization is to offset the negative effects of current international economic order and to avoid the embarrassing situation caused by international monetary system. To China, The shortcoming of the current international monetary system has posed a big threat to its economy. Since its accession to the WTO, China has become the second largest trader in the world, exporting and importing huge amount of goods and services before the financial crisis. Most of the goods and services are priced and settled in the US dollar, some in euro and a smaller share in the Japanese Yen or the British Pound, etc. The big fluctuation of major international currencies seriously affects China’s foreign trade and investment, casting strong uncertainties to China’s exporters and importers, and increasing their cost of hedging against the exchange fluctuation. Besides, China imports almost half of the oil it needs every year from abroad. With the oil priced almost entirely in the US dollar, China would get strategically unsatisfied when the US dollar devalues and the oil prices rise. In 2011, although China’s oil import volume only increased by 6%, China paid 45.3% more money due to the devaluation of the US dollar and the appreciation of the RMB.[①]

The second inconvenient fact for China is too much of the US dollar reserve accumulation and related consequences. Before the crisis, China had mainly depended on exports and investment for economic growth. For sure, in order to prevent the RMB from being too strong to influence China’s export competitiveness, China buys the foreign exchange income from those exporters while restricting overseas investment. As a result, the Central Bank accumulated huge amounts of foreign exchange reserve, most of which are invested in the US Treasuries and other US assets. With the US dollar devaluation, China’s government worries the possible loss very much. And the domestic public opinion has been criticizing the government of endangering Chinese people’s money gained through hard work.

The combination of too much trade surplus, the de facto fixed exchange rate and huge foreign exchange reserve accumulation has led to another very serious problem. The central bank of China is forced to print a lot of money in buying the foreign exchanges as the exporters are required to sell them to the central banks, which leads to huge inflation pressure and assets bubble. China’s economic resources are wrongly priced and the economic structure is misled and distorted. Alongside, the inflation and assets bubble caused huge social discontent in China, which bring many mass incidents. The government is afraid that if the trend continues, the society could sink into turmoil. That’s the major reason why China has eased its control over RMB exchange rate since July 2005; for sure the US pressure plays its role as well.

Diplomatically, China wants to use RMB internationalization to reduce the necessity of keeping the fixed rates of it as to maintain its export competitiveness, which has been the biggest economic flashpoint between China and the US since the early 2000s. China wants to reduce the conflict by internationalizing RMB, depending more on its own currency to deal with international transactions and reach the balance of exchange rate between the RMB and the US dollar.

Of course, the huge potential economic and strategic interests of being an international currency issuer also encourage Chinese leaders to promote the internationalization of RMB.

Currently, the most attractive side of RMB internationalization is the potential facilitation role the internationalized RMB can play in reducing the cost of China’s overseas investment and importing goods from other countries, which is very important to match with the transformation of China’s economic growth model, from depending on export and FDI to expanding domestic consumption markets and outbound direct and portfolio investment in the following years. In the past thirty plus years, with its opening up and liberalization policy, China’s efficiency in utilizing its economic resources has been greatly increased. Although there is still quite much margin to squeeze, the marginal return should be much less if continuing to open China itself for foreign investors. With this in mind, and with the huge capital China has accumulated in the past decades, China realizes the importance of not only utilizing its own economic resources but also those in the rest of the world. So China tries to start a new phase of opening up strategy, i.e., the Going Global Strategy, which encourages Chinese enterprises to invest abroad. Simultaneously, China also encourages the import of necessary goods and resources for Chinese to further improve their living standard. But if the investment and import still use the US dollar as the pricing & settlement currency, China’s investment and import capability and stability will be subjected to the policies of the United States and will have higher transaction cost. However, if these investment and import can be priced and transacted in the RMB, then China can almost provide non-limited capacity for the investment and import financing, the transaction costs for the Chinese enterprises could be much lower as well. One possible area is Africa. China can import their goods and resources by paying RMB, and the African countries can import Chinese goods and services by paying the RMB income back to China. There is indeed a huge potential.

The RMB internationalization will also be instrumental to promoting the reform of China’s financial system. In contrast to the real economy sector (manufacturing), which has been extremely liberalized with accession to the WTO, China’s financial system remains mainly state controlled and low efficient, which lies at the bottom of so many economic distortions in China. The internationalization will bring pressure and competition from external side to accelerate the financial reform process, such as liberalization of domestic bond markets, stock markets, interest rate formation mechanism, etc.

In geopolitics/geoeconomics side, the internationalization of the RMB, especially in East Asia, will strengthen China’s economic links with its neighbors and its influence on regional economic and financial cooperation (intraregional trade, Asian regional capital markets, crisis prevention and management), which is very critical for China to get a stable backyard.

Globally, the internationalization of the RMB will offset to some degree the strategic advantage of the US of being the dominant international currency owner and pave the first steps for China to take on a bigger role in world economy. We all know the international currency status of the US dollar has been so important for the US to experience more than 30 years of trade deficits while still remaining competitive in world economy.

China wants to see a more comprehensive and balanced international monetary system consisting at least of the US dollar, the Euro and the RMB and even some other major currencies, such as the Japanese Yen, Rupee, etc., which will give the world economy more choices whether in terms of investment, trade or stock of values and the competition among the major international currency issuers will produce better result for the world in general.

II. The Basis of RMB Internationalization

To be an international currency, the issuer nation should have a very strong economic and political power basis. Few countries in the world can be lucky/unlucky enough to take on this role. However, with more than thirty years of fast economic growth and political stability, China now mounts to be close to the crown status.

China now is on the top list of world investors and traders, which means the international transactions involved with China are huge. Therefore, China’s preference in terms of those international transactions would have strong influence on the means and methods related. Some people argue that the US only got dollar as the international currency after almost 60 years of becoming the No.1 GDP country in the world. However, as Prof. Arvind Subramanian indicates, though China now is only the second largest economy in the world, but it has much bigger share of international trade and investment compared the US in the late 19th century.[②]

The most important basis should be China’s domestic market and so its capacity to import. Now China’s economic scale is already very big so that though the consumption’s share in GDP is still very low compared to other nations, its domestic market is becoming the second largest in the world only after the US (EU is not considered as a nation). More importantly, thanks to the booming middle class of the country, the market is predicted to be the No. 1 in the world in less than 10 years. China’s growing domestic market will provide huge room for absorbing oversea products and services, which constructs the basis for China to flow out RMB while importing foreign goods and services, just like the US has been doing in last several decades.

China’s financial system has achieved quite much progress, especially in terms of infrastructure building. Now it has pretty sound regulatory institutions, commercial banking system, security transaction brokers and many listed companies. What is more important, as the result of recent years’ efforts, China’s financial system has accumulated many international experiences and talented people, which is a very important basis for further financial reform and for coping with the RMB internationalization’s spillover effects.

Besides, China’s politics and society in general are very stable. In China, the collective leadership style helps to maintain political stability and avoid serious policy wrongs. Militarily, China is a big power as well. The political stability, the continuing macroeconomic policy framework, the military ability to maintain domestic and cross-border security and even international peace render China with quite strong credit to be an international currency issuer.

The external factor cannot be ignored. But fortunately, by accumulating so much US dollar assets, Chinese government successfully realizes the deeper economic interdependence with the US, which broadens the common interests to cooperate in many fields and is helpful in stabilizing the bilateral relations. In the contrast sense, it forms a mutual assured destruction of mass financial weapons between the two countries: if the US pushes China too hard, China might stop buying US treasuries, pushing higher the yield rate, and if China behaves negative to the US, the US can devaluate the US dollar to reduce the value of China’s state owned overseas assets. Either calling it deeper economic interdependence or mutual mass financial destruction weapons, China and the US are indeed bound together, which is in the strategic interest of China, especially when it was at the initial stage of its economic growth. In this context, although the US might feel not very happy to see the role of the RMB to be stronger internationally, it cannot endanger itself by taking any substantial measures to disrupt China’s RMB internationalization process.

III. Channels and Progress of RMB Internationalization

1) For the RMB to flow out of China

To be an international currency, the issuing nation needs to flow out the currency beyond its borders and to recycle the currency through many mechanisms, which can insure the liquidity of the currency. Though China’s government is very cautious about the possible negative effects of the internationalization of RMB, it does have established quite a few channels to promote the cross-border use of RMB and some monumental achievements have been obtained.

Currency swaps agreements are becoming the vanguards of RMB internationalization. China now has currency swap agreements with 19 partner economies (See Table 1). It is also reported that China would like to have a swap agreement with India,[③] but India might still be hesitant because of some doubts over China’s intention. These swap agreements have different functions: Argentina mainly uses the RMB in trade payments; Belarus uses the RMB as reserve; Korea uses the RMB to finance its enterprises in China; Hong Kong uses it to satisfy RMB demand in offshore RMB business. In general, RMB swaps agreements are helpful to deal with short term liquidity problems, maintain financial stability, while China is using them to promote the use of RMB.[④]

In order to promote the RMB to be used as the trade settlement currency, China is actively seeking to reach agreements with its trade partners on bilateral trade settlement with their own currencies, which includes the agreements of China-Belarus in March 2010, China-Russia in June 2011, China-Japan in December 2011, among BRICS countries in March 2012, among SCO members in June 2012, China-Argentina in June 2012, China-Australia in April 2013, and etc.[⑤]

In April 2009, Chinese government started the pilot programs for cross-border RMB settlement in 5 big cities (Shanghai, Guangzhou, Zhuhai, Shenzhen and Dongguan) as they trades with Hong Kong, Macao and ASEAN area, which was the profound step for RMB internationalization. In September 2010, the program was expanded to all oversea trading partners and domestically to 19 provinces and municipalities.[⑥] In August 2011, the program was expanded to all across China.[⑦] RMB became a full applicable currency for Chinese enterprises to settle with their trade business.

The program witnesses significant progress. Before June 2009, the RMB trade settlement volume was almost close to zero, but in 2010 the RMB trade settlement accounted for 2% of all China’s international trade, and rising to 10% of 2011. In 2012, RMB trade settlement volume reached 2.94 trillion, increasing by 41% compared to that of 2011. In which, trade of goods settlement volume is RMB2.06 trillion and trade of service settlement volume and other current account items is RMB876.5 billion. The income of RMB is 1.3 trillion, while payment of RMB is 1.57 trillion, indicating a net outflow of RMB269.2 billion from China. The income/payment ratio of RMB trade settlement in 2012 is 1:1.2, rising from 1:1.7 in 2011.[⑧] In the first quarter of 2013, the RMB trade settlement develops even faster, as the volume reached 1.004 trillion, increasing by 72.3% compared to the same period of 2012, receiving 416.7 billion and paying 587.2 billion.[⑨] If the rising pace keeps above 50%, the RMB trade volume in 2013 would reach at least 4.5 trillion.

The RMB could also play a very important role and find its place in China’s oversea direct investment. China has been mainly a receiver of direct investment in the past 30 plus years and played a quite limited role as an outbound investor. Before 2002, it was very rare to hear some Chinese enterprises invest abroad. However, as China’s economic scale grows fast, its outbound investment grows as well. During 2002-2011, China’s outbound direct investment increases by annual rate of 44.6%.[⑩] In 2012, China’s outbound direct investment amounts to 77.2 billion US dollar, increasing by an annual rate of 28.6%.[11] Given the huge volume, there is very big potential for RMB outbound direct investment of China, especially in development countries. In January 2011, Chinese government started the pilot program on RMB outbound direct investment.[12] In October 2011, the PBC issued a guideline on RMB loans of Chinese financial institutions to those oversea projects.[13] With these policy incentives, the RMB outbound direct investment develops quite fast. In 2011, the volume of RMB outbound direct investment of China is 20.2 billion[14], which grows to 30.4 billion in 2012,[15] increasing by 50%.

In May 2012, Iran accepted the RMB as the trade currency for its oil sold toward China.[16] This has not got proven yet by any authorities in both Iran and China sides. But from the perspective of Iran, it does have the incentive to do this as the US put many sanctions on it; China also has very strong incentives to do this, as mentioned above, using RMB to buy oil will reduce much of the exchange rate risks it has been taking. There is much discussion that China and Russia will use RMB to be the transaction currency for their oil trade. Another important oil exporter, Sudan also expressed its willingness to transact its trade with China in RMB and its pound.[17] The speculation itself on these issues has shown the potential capability for China to replace the US dollar in this very sensitive area.

China now is becoming one of the most important development assistance providers, even providing more assistance to developing countries than the World Bank during 2009-2010.[18] China can provide RMB loans, assistance and import credit to developing countries, which will help the developing countries to get finance for their needs and also promote the utilization of the RMB, and even more importantly, educate the habit of use of a new international currency in the developing world.

With those international financial institutions needing more financial resources, China has the chance to promote the use of the RMB in the programs of very prestigious multilateral institutions like the IMF. In September 2009, China agreed to use the RMB to buy 50 Billion US dollar IMF bonds. This could become a very special but effective channel for China to both provide more resources to international institutions and expand the influence of the RMB in the world.

RMB assets are going to be adopted by more and more countries as the foreign exchange reserve. In the past, there were few countries which would collect limited volume of RMB currencies, which mainly comes from trade transactions, to be one of their reserve assets. But in recent years, more and more countries would directly buy China’s Treasuries to be their foreign reserves. In March 2012, Japan declared it got a quota to buy at most 65 billion China’s Treasuries to be one component of its reserve assets.[19] In April 2013, Reserve Bank of Australia decided to invest 5% of its foreign exchange reserve in China’s Treasuries.[20] Japan and Australia are two important advanced economies in Asia-Pacific area. Their decisions would form kind of endorsement for RMB’s credit. At the same time, Saudi Arabia is also said to use RMB assets as its reserve; Korea, Indonesia, Malaysia and Cambodia have done or are going to do as well.[21] Although currently the RMB assets in total global foreign exchange reserve pool is still quite small, the fast growing numbers of countries who would use RMB as reserve currency declares its growing status.

Direct trading between RMB and other currencies deserves close observation as well. Since June 2012, it is allowed to directly exchange between the RMB and Japanese Yen in China, and in April 2013, China and Australia reached to direct trading RMB and AUD in onshore market as well, which will rip off US dollar’s role of mediation. China and Japan are the No. 2 and 3 economies in the world and Australia is both an important resource-intensive and economically developed country. Their practice in terms of currency relations will soon be copied by many countries. If trend continues, then RMB’s status will climb, while the US dollar’s relevance among them will decline relatively.

To be owned by overseas private savings, such as in Hong Kong, Taiwan, Singapore and London, either for transaction use or stock of value and even targeted for RMB appreciation. According to recent report, the offshore RMB stock has reached around 1 trillion.[22]

2) For the RMB to flow back to China

The most important way to get back RMB is for other countries to import China’s goods and services and pay in the RMB they have in hand. This would reflect outside world’s belief in the RMB. As discussed above and displayed in Figure 1, China received RMB742.9 billion in 2011, RMB1.30 trillion in 2012 respectively for its export of goods and services. In the first quarter of 2013, China’s income of RMB by exporting goods and services is 416.7 billion. These data shows the export can play a very important role to recycle the offshore RMB back to China.

The second important way to get back RMB is for foreign enterprises to make RMB direct investment in China. In October 2011, PBC initiated the RMB FDI program.[23] Since then, foreign direct investment in RMB has increased significantly. In 2011, the RMB FDI volume is 90.72 billion. The number grows to 253.6 billion in 2012. In the first quarter of 2013, the volume is 77.4 billion.[24]

The third important channel is offshore Yuan Bonds (Dimsum Bonds, 点心债券) in Hong Kong (US$2.3 billion in 2009, US$5.4 billion in 2010, US$14 billion in 2011) and in London (HSBC fist, 2012 April, RMB2 billion) and possibly in Taiwan and other financial centers.

The fourth channel is onshore Yuan Bonds (Panda Bonds, 熊猫债券) in China’s mainland since 2005 (IFC, ADB), mainly used to support their business inside China. Besides, China’s government has an innovation to promote the recycling of RMB depositing outside China, while maintaining control over the capital account. That is RQFII (RMB qualified foreign institutional investors) program, which allows qualified foreign financial institutions to invest China’s financial markets within certain quota.

3) The main financial centers for RMB internationalization

For the RMB business, the onshore center will be located in Shanghai. China has decided to build Shanghai into an international financial center, but currently the legal environment, financial derivatives and regulation expertise are not fully prepared yet. As outlined in “The 12th Five Year Plan of the Development and Reform of Financial Sector”,[25] Shanghai will experience profound reform of its financial system and prepare to play the central role for onshore RMB business.

Offshore centers will probably include Hong Kong, London, Singapore, Taiwan, and Dubai. These cities/places are competing for the offshore RMB business center, in which Hong Kong has very special advantages, including geographical position, more familiar with mainland legal and social environment, the strong support from the Central government of China etc. while London has the high international reputation for its advantage in offshore finance and expertise.

IV. Impacts of RMB Internationalization

Regionally, RMB could function as a de facto common currency in the near future, given China’s economic scale could reach at least two times that of Japan in around ten years, ever growing intra-Asia trade and investment, China’s fast growing domestic market to integrate regional economic resources and the further development of intra-Asia capital markets;

East Asia could possibly become the second largest monetary and financial cooperation area in the world, after the Euro Zone, which will further promote regional macro-economic policy cooperation and coordination, meanwhile the mechanism like the CMIM (Chiang Mai Initiative Multilateralisation) will get more institutionalized and political support;

A more economically and financially integrated East Asia will naturally produce a more consensus-oriented regional voice in international affairs, whether in economic area, environment area or security area;

The international monetary system could be more diversified and balanced, which will not only give the world more choices to do business, but also force the major economies to be more responsible in making policies in order to continue their international currency status;

Commodity prices will not so easily be influenced by the exchange rate of the US dollar. Up to now, most of commodities’ prices are linked to the US dollar. As the US dollar exchange rate fluctuates, so do the commodity prices, which causes many troubles and uncertainties to the development of world economy;

Global macro-economic environment could be more stable than now. Currently the US dollar is the dominant international currency, but the US monetary authority (FED) is only responsible for its domestic concerns and ignoring the possible spillover effects to the rest of the world. Sometimes people would think the Fed is intentionally manipulating the so-called independent status to transfer the cost of economic restructuring of the US itself to the rest of the world. As there are more international currencies, especially when the other two (Euro and RMB) almost have a similar economic basis with the US, any single among the three will not be as easy as the US now to have so strong spill-over effect of its own domestic macro-economic/monetary policies;

US power basis could be weakened. The international currency status of the dollar provides the US with great potential. The US can almost finance its oversea actions (military, aid, investment etc.) at very low cost, while only needs to keep a little bit distance to the balance line. With more alternatives, the margin for the US would be greatly narrowed, which for sure will weaken the power basis of the US.

With the US monetary power basis weakened, RMB’s status poised higher and the Euro recovering to its normal status, the world power structure would adjust accordingly. Because finance sector now plays a very important role in economy, the realignment of international currencies will bring great impact on international financial clout distribution. The power structure adjustment could even be bigger.

EU-US-China relations will become more uncertain. As this crisis clearly shows, the US does not have any strong interests in supporting the stability and status of the Euro, which reveals the fragile side of the transatlantic relations. Simultaneously, China plays a positive role to help the Euro Zone, which the core European countries including Germany and France are very clear. If the RMB gets to be more internationalized, the trilateral relations could be more subtle and subject to many political and economic interactions among them.

V. Prospects of RMB Internationalization

In economic dimension, it deserves optimism: as long as China can maintain internal stability and normal economic growth, the RMB will sooner or later become one of the major international currencies, as it has very big economic scale and pretty high international interdependence.

However, the further development and reform of a modern financial system is the precondition for the RMB to become a real international reserve currency. In this sense, China does have a long way to go. But it is moving quite fast. The interest rate formation mechanism is changing; private capital is allowed to enter banking sector; an international board in Shanghai Stock Exchange is in serious discussion; a more flexible management of foreign participants in China’s bond markets is under shaping.

Moreover, the outside factors are important as well. There are quite many uncertainties as to how the US will respond to the possible loss of the single dominant status of the US dollar. We are not sure whether or not the transformation of international monetary system could take place smoothly and peacefully.

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