Rmb: Towards Internationalization

Siwei Cheng

• Publisher: WSPC
• Year: 2015
• ISBN:
  9789814644679
• Topic: Sciences biologiques
• Subtopic: Science générale

RMB: Towards Internationalization takes an in-depth look at the exchange rate regime of China's currency, the RMB, including the arrangements, related policies and management, and corresponding policy recommendations. This is the first book to apply the theories of fictitious economy, complexity science and the principles of international finance to analyze the RMB exchange rate regime. For readers interested in China's economy in general and RMB internationalization in particular, this book provides an entirely new analytical framework on the history and evolution of RMB exchange regime and on its future development.

Contents:

• RMB Internalization is an Irreversible Trend
• Exchange Rates under the Perspective of Fictitious Economy
• The Choice of Exchange Rate Arrangement — Empirical Analysis
• The Choice of Exchange Rate Arrangement — Case Study
• Evolution of the RMB Exchange Rate Regime
• The Determination of a Central Rate for the RMB
• The Opening Up of Capital Account
• Path to RMB Internationalization

Readership: Researchers, economists, finance professionals, analysts, individual investors, monetary and banking authorities in Asia and those who are interested in China's exchange rate regimes and the future of its currency, the RMB.

Chapter 1

RMB Internationalization Is an Irreversible Trend

1.1Introduction

In recent years, with China’s rapid economic development and rising international status, the RMB’s exchange rate has aroused much concern at home and abroad. There are several reasons for this.

First, since China adopted the reform and opening up policy 34 years ago, its economy has turned more export-oriented and its dependency on foreign trade (exports’ and imports’ share of GDP) has risen sharply from 9.7% in 1978 to 47% in 2012 (after hitting a record high of 67% in 2006). Changes in exchange rates can therefore significantly affect not only the prices of Chinese commodity exports, but also the performance and structure of its foreign trade, and even China’s overall economic growth.

Second, because of China’s comparative advantages — including abundant human resources and lower prices — its foreign trade has grown from a deficit of USD$1.14 billion in 1978 to a surplus of USD$231.1 billion in 2012. Such a long-term imbalance in imports and exports has caused increasing trade frictions and put more pressure on the RMB to appreciate.

Third, due to China’s rapid economic growth, huge market potential, high quality and low-priced human resources, fine infrastructure facilities and favorable investment environment, China is becoming increasingly attractive to foreign investors. Average annual investments flowing into China’s non-financial sector have soared from USD$1.956 billion in 1985 to USD$111.7 billion in 2012. Numerous world-famous multinational companies in China now are clearly taking the RMB exchange rate into consideration when making investment decisions.

Fourth, the foreign trade surplus plus the net inflow of foreign capital has resulted in a continued capital and current account surplus. These have built up China’s foreign exchange reserves, which expanded from USD$167 million at the end of 1978 to USD$3.3116 trillion by the end of 2012. While such huge foreign exchange reserves enhance China’s economic strength, they may also pose risks due to exchange rate fluctuations.

Fifth, China’s overseas investment has been surging in recent years. In 2012, non-financial foreign direct investment grew 28.6% year on year to USD$77.2 billion, posing new challenges to the RMB exchange rate and China’s foreign exchange management mechanisms.

Sixth, as the income of China’s urban and rural residents continues to increase, ever greater numbers of people are purchasing imported goods and travelling abroad. Changes in exchange rates affect the RMB’s international purchasing power and thereby the behaviors and structure of Chinese citizens’ consumption.

Lastly, the effect of the RMB exchange rate on China’s fictitious economy should also be noted. The exchange rate influences cross-border, short-term capital flows, financial asset prices, inflation and deflation trends, and other factors affecting China’s economic stability and security. Thus, the RMB exchange rate is a major issue that involves the national economy and people’s livelihood. Any policy recommendation dealing with the exchange rate calls for discretion.

Since 2003, China’s economic development, further opening up and increasing national strength have all put its exchange rate in the spotlight. The United States, Japan and other developed countries have all demanded appreciation of the RMB. At the G7 Summit in the spring of 2003, Japan accused China of using the undervalued RMB to dump cheap products on the international market, causing deflation in the international community. Later, United States congressmen claimed that cheap Chinese exports to the United States had resulted in higher unemployment rates in the US, a huge trade deficit, and even economic stagnation. Some in the US Congress even threatened to impose a 27.5% tariff on imported Chinese products through legislation, unless the RMB could be appreciated by 30% to 40%. Some foreign media reports also added fuel to the fire, which severely affected RMB exchange rate expectations and placed even greater pressure on RMB exchange rates and the international balance of payments.

On July 21, 2005, China launched reforms in the RMB exchange rate mechanism. These were based on market supply and demand, with reference to a currency basket, allowing the RMB to fluctuate within a certain range. The changes promised to enhance the exchange rate’s flexibility through market mechanisms. Since then the RMB’s exchange rate against the US Dollar has been increasing and, by the end of 2012, the exchange rate against the US Dollar had reached RMB6.2855 to USD$1, with an accumulative appreciation range of 32%. Although the RMB exchange rate against the US Dollar has dipped from time to time, the RMB is still expected to remain strong against the US Dollar. At the same time, the pressure of RMB appreciation can also be felt against the Euro and the Yen. In the short run, factors such as China’s rapid economic development and the double-digit surplus in its international balance of payments will linger, China’s high dependence on foreign trade will continue and the exportoriented economic structure formed by large-scale foreign direct investment (FDI) in China will remain unchanged. Thus external pressure on the RMB exchange rate will continue apace. Although a currency’s exchange rate, exchange rate mechanism and related policies should be determined by the state that issues the currency, given that the exchange rate of the RMB affects the global economy, external pressures from Western countries cannot be ignored. Judging from the trends, China will endure great pressure for RMB appreciation in the long term, during which time it must exercise careful consideration and discretion.

It should also be noted that economic globalization and regional integration have made the circulation of production factors much easier than before, enabling optimized allocation of resources in real economies. To make this happen, fictitious economies (corresponding with real economies) must also go global: The internationalization of financial markets is necessary. With the faster and larger scale of international capital flows in recent years, financial markets in different countries have grown closer than ever and the global financial market can be affected by even slight changes within countries. It is fair to say that no country can achieve economic development with a completely closed financial market, which means further globalization of financial markets should be promoted.

A globalized financial system also means that financial turmoil in one economy can spread to the rest of the world, from fictitious economies to real economies, and finally lead to a global crisis. The global financial crisis — caused by the US subprime mortgage crisis — has indicated the need to reform international financial mechanisms to make them more responsive to current needs. China, as a developing country with a total economic output and trade volume second only to the US, is contributing 10% to the global gross domestic product, 9% to global trade volume, and a quarter to global economic growth. Therefore, it should have a say in the international financial market and play a more significant role in restoring the international financial order. However, to make this happen, China must further deepen reform of the RMB exchange rate regime, enable free convertibility of the RMB, open up the capital account in an active, but steady way, and promote the internationalization of the RMB.

1.2The Implications of RMB Internationalization

As the name implies, an internationalized currency can circulate and be transacted internationally, with no set borders. It would offer traditional functions, such as being a store of value, a medium of exchange, a unit of pricing, and a generally accepted means of payment in the international market.

So far, most studies on RMB internationalization are conceptual, and many valuable results have been obtained. However, this book holds that, from a scientific and management perspective, analysis of the implications of RMB internationalization should include its goals, means and processes. That is, RMB internationalization is simultaneously a goal, a means, and a process.

1.2.1The Ultimate Goal of RMB Internationalization

China, as a major developing country, is playing an increasingly significant role in global politics and the global economy. Thus an internationalized RMB should be standing side by side with the US Dollar and the Euro in the international currency system.

First, in the future, the RMB should be convertible within and outside of China. Consumers will have access to RMB accounts in foreign banks and use RMB-based credit and debit cards outside of China and small amounts of RMB cash on special occasions.

Second, RMB will be used as a unit of pricing in international trade (which may or may not involve China as a participant).

Third, in international trade settlements, RMB will be used as a currency of payment. In some international trade activities, even if RMB is not a denominated currency, the payment can be settled in RMB with consensus between buyers and sellers.

Fourth, RMB will be used in international investment and financing. This means that, besides greenfield investment and cross-border acquisitions in the real economy, RMB will also be used in various financial assets and their derivatives in the fictitious economy, including stocks, bonds, bills, insurance policies, guarantees, futures, options, forwards, and swaps, etc.

Fifth, the RMB can serve as an international reserve currency. Alongside its use by governments and central banks in foreign exchange markets, the RMB should also play a role in Special Drawing Rights (SDR).

It should be noted that China’s current economic volume ranks third after the European Union and the United States. Because of its large population, resource shortages and unique political system, it is difficult for China to establish mutual trust with most developed countries. And because China’s society, economy, technology and culture remain relatively underdeveloped, its financial system lacks competitiveness. Even with a fully convertible RMB, China still has a long way to go. According to the “2013 RMB Internationalization Report” released by the International Monetary Institute of Renmin University of China on June 16, 2013, the RMB Internationalization Index (RII) was only 0.87, as compared to 52.34 and 23.60 for the US Dollar and the Euro, respectively. This book holds that, with favorable international conditions and successful domestic reforms, the internationalization of the RMB can be achieved within ten years. But for the RMB to become a fully internationalized currency, it may take 20–30 years, if not longer, and calls for careful planning, phased goals, great efforts and step-by-step implementation.

1.2.2The Internationalization of the RMB Is a Key Step in Achieving China’s Goal of Strategic Development

At its 18th National Congress, the Communist Party of China again specified China’s goal of strategic development. China will strive to build a comprehensive, well-off society by 2020 and a prosperous, democratic, highly civilized, harmonious modern socialist country by 2049. RMB internationalization is thus more of a way to deepen reforms and further open up, rather than a goal in and of itself.

The past half century has witnessed rapid development in the fictitious economy, with finance as its backbone. The total volume of the world’s fictitious economy (including the market value of stocks, bond balances, as well as the notional amounts outstanding financial derivatives) exceeds USD$800 trillion. In certain developed countries, the real economy only contributes 50% to GDP. After breaking free from the gold standard system and gold convertibility, currencies are now issued according to state credit, which enables developed countries to “bully” developing countries financially. Unlike centuries ago when capitalist countries had to literally rob their colonies and poverty-stricken countries of labor and natural resources, today, to get the same economic benefits, all they need to do is purchase products and energy resources in their own currency from underdeveloped countries. These payments, in the form of foreign reserves, can only be spent on technology license and high-tech products produced by developed countries (with many restrictions). The rest can only go to financial products such as state bonds. In this way, foreign reserves acquired by developing countries actually flow back into the developed countries.

China, the largest developing country nowadays, also has the largest foreign exchange reserves, which stood at USD$3.3116 trillion at the end of 2012. However, due to the low level of the RMB’s internationalization, China’s spending is in many ways restricted. For example, in the case of a strong RMB, export contracts denominated and settled in RMB would benefit China’s export enterprises. But in 2012, only RMB350 billion of cross-border trade settlement was made in RMB (accounting for 17.5% of the annual total). Another example is FDI. In 2012, the actual utilized FDI in non-financial investments registered USD$111.7 billion, of which only RMB253.58 billion (36.1%) was made in RMB. Of the USD$77.2 billion in non-financial overseas direct investment, only RMB30.44 billion (6.3%) was made in RMB. Moreover, in 2012, international bonds and notes denominated in RMB accounted for only 0.27% of the world’s total (International Monetary Institute, Renmin University, 2013). In addition, only a few countries (such as Cambodia) have incorporated RMB into their foreign exchange reserves, and the SDR cannot at present be exchanged for RMB. Therefore, China’s foreign exchange reserves are mostly used to buy foreign bonds. This means China is supporting the economic development of other countries at the expense of its own wealth: The average yield on US bonds is only 4% as compared to the 8% average return on investment. Moreover, China has to bear any losses caused by foreign currency devaluation on those reserves. However, China has no better alternatives at the time being.

Although the RMB is the sovereign currency of the largest developing economy, it is somehow invisible in the international monetary system, not to mention in the international allocation of financial resources. With favorable conditions such as a stable political environment, relatively rapid economic development, balanced foreign trade, stable currency value and abundant foreign currency reserves, China should make efforts to achieve internationalization of the RMB and become a more active player in international financial markets and the international monetary system in general. Only in this way can China take the initiative in international economic competition and acquire a higher international status.

An internationalized RMB can also help promote China’s domestic financial reform and promote sound and rapid economic development. China still needs to further open its financial sector, improve efficiency, and strengthen competitiveness, which will be made easier with an internationalized RMB.

First, China should reform its exchange rate regime. Although China claims to base its current exchange rate regime on market supply and demand with reference to a basket of currencies, the currency is still heavily managed. Likewise, although China allows the exchange rate to fluctuate within a certain range, no real fluctuations have been observed during its appreciation. It appears to still maintain a “soft” peg to the USD. According to the 2009 IMF report titled “Revised System for the Classification of Exchange Rate Arrangements”, China’s exchange rate regime is classified as a “conventional fixed peg arrangement” under a “soft peg”, which, according to our research, actually functions more like a “hard peg”. In the 2011 version of the report, China was placed under a “crawl-like arrangement”. Indeed, both the 2009 and 2011 reports classified China’s monetary policy framework as using the USD as an “exchange rate anchor”. The internationalization of the RMB will make China’s exchange rate regime more market-oriented and more reliant on a basket of currencies. Its transparency and flexibility will grow, and its dependence on the USD will gradually fade away.

Second, an internationalized RMB can promote market-oriented interest rate reform. With the internationalization of the RMB, China is bound to relax controls on interest rates so that domestic and foreign commercial banks can arrange their funds according to supply and demand at home and abroad. In this way, capital efficiency will increase and arbitrage s...

Table of contents

• Cover Page
• Title Page
• Copyright
• Preface
• Contents
• Chapter 1 RMB Internationalization Is an Irreversible Trend
• Chapter 2 Exchange Rates under the Perspective of Fictitious Economy
• Chapter 3 The Choice of Exchange Rate Arrangement — Empirical Analysis
• Chapter 4 The Choice of Exchange Rate Arrangement — Case Study
• Chapter 5 Evolution of the RMB Exchange Rate Regime
• Chapter 6 The Determination of a Central Rate for the RMB
• Chapter 7 The Opening Up of Capital Account
• Chapter 8 Path to RMB Internationalization
• Index