Can the Renminbi become an international currency?

Guest blogger Frederik Vitting Hermann looks at the more widespread use of China’s currency around the globe. Conditions in the domestic market and the Chinese incremental reform style of monetary authorities make full internationalization within the next ten years implausible.

SWIFT, the communications platform most banks use for international orders, announced that the Chinese renminbi (RMB) climbed into the top ten most used currencies for payments in November and December 2013, accounting for 1.12 percent of global payments in December, trailing the Swiss Franc – considered a reserve currency by many – by only 0.17 percentage points.

The news fed into the ongoing debate, speculation and expectations for a fully international Chinese currency. Following China’s increasing share of the international economy, it is natural for its currency to attain wider use on a globally, but the Chinese government keeps the renminbi on a tight leash. It is especially reluctant to allow for the necessary capital account liberalization for the renminbi to become a competitor to the pound, the euro and the dollar.

The renminbi is moving forwards as an international means of payment however. It breached into another top ten in June 2013, when the Bank of International Settlements released its Triennial Central Bank Survey. It moved from 17^th in 2010 to 9^th in 2013 in the share of global FX turnover, accounting for 2.2 percent.

A more important gauge of investor attitudes towards the RMB, there was a shift in the composition of RMB trade with outright forwards going down and FX swaps going up. The use of forwards is mostly a hedge against currency risk. As the Peoples Bank of China has gradually appreciated the RMB against the dollar, RMB transactions have shifted to swaps, which are often used to fund institutions’ foreign exchange balances. Thus, the RMB is converging towards the trading composition of the major currencies.

FX trading composition

Data: BIS: https://www.bis.org/publ/rpfx13.htm

A currency is, however, more than a medium of exchange. As a store of value, the RMB has a long way to go internationally, due to China’s mostly closed capital account. In spite of the offshore dim sum bonds traded mainly in Hong Kong, Taiwan, Singapore and London, there is nothing near a deep and liquid market for RMB-denominated securities needed for institutional investors to start looking at the RMB as an investment vehicle.

As of September 2013, outstanding dim-sum bonds, notes and money market instruments reached $80 billion in value. This is miniscule against the world’s largest currencies.

Table 2: Internationally traded bonds outstanding as of September 2013.

Data: BIS: http://www.bis.org/statistics/secstats.htm and own summations

The onshore market (the one behind closed capital accounts) is at $4.048 billion in dollar terms. This is still only about an eighth of the domestic U.S. debt market (which stood at $33.442 billion in 2011). Still, China has a sizeable market about the same size as Germany. If the capital account were opened tomorrow, the bond market size would be competitive, but concerns about liquidity and policy stability would still dampen investment enthusiasm.

With regard to liquidity, Chinese government bond bid-ask spread prices have declined over some years. They now stand at two basis points, compared to a U.S. average of 0.3 basis points. Market turnover in corporate and government bonds, another liquidity measure, is around 2 compared to a U.S. turnover ratio of around 8 in all U.S. bond markets.

Liquidity increases as capital accounts become more open, and liquidity is important for attracting foreign market investors. In the meantime China will have to establish exchanges and clearinghouses to push turnover and reduce transaction costs.

That said, there are still worries about the policy climate in Chinese money markets. On October 17^th, 2013, the People’s Bank of China (PBOC) stopped their reverse repo operations causing a sudden spike in SHIBOR. The PBOC again opened its repo facility two weeks later, but the central bank has consistently tried to tighten liquidity as a means to deleverage the Chinese economy. Yields on both government and corporate bonds have gone up as a result.

The RMB does not yet have the financial market backing to compete with today’s international currencies. But there is no doubt it is climbing the ranks as a means of exchange. That might be all that China is aiming for.

Since Premier Li Keqiang’s statement in September and the Third Plenum of the Chinese Communist Party Central Committee, people have been anxious about the renminbi and liberalization of China’s capital account. But there is a long way before international banks use the RMB for liquidity management, global institutional investors include RMB assets as active portfolios or multinational corporations incorporate RMB into cash management programs.

It is not clear what China’s interest in this exorbitant privilege is beyond the prestige. For now, the limited internationalization to reduce transaction costs of trade are both in the interest of and within reach for China. Incremental opening will progress slowly but steadily.

Frederik Vitting Hermann is a political science masters student at the University of Copenhagen currently at UC Berkeley. Previously employed at the Danish Ministry of Finance and at a Danish news magazine he writes on international political economy.