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The Future Development of the Renmibi as a global Reserve currency

Updated on August 15, 2017

The potential of the renminbi in serving as a world reserve currency has gained heighted attention in the current perspective. For many years, China has been campaigning to have its national currency the renminbi alongside the British pound, the United States dollar, the Japanese yen, and the euro included in the International Monetary Fund basket. China’s push to have its currency to act as a reserve in the global market is drawn by different motives. Among these includes the possibility reducing the necessity of holding massive reserves, and making it more stable. Moreover, Chinese authorities will no longer have the need of suppressing domestic demand so as to sustain the different varieties of reserves, thus stir high consumption which will subsequently supplant fixed-asset investment. This will help in placing the economy of China on a more sustainable level. Furthermore, it will make it easier for excess funds to be allocated to sovereign wealth funds for the purpose of financing projects including through the novel Asian Infrastructure Investment Bank which is significantly extending the global influence of China (Friedman, 2015).

The renminbi, which is China’s official currency, is being promoted by the nation for international use. The goals for these initiatives are to enable the settlement of various local and international trade transactions using the renmibi and to facilitate the cross-border remittances of the renminbi for transactions. In addition, the move is also focused at enabling the provision of the renminbi dominated bonds in China and foreign nations. This measure will as well facilitate setting up of bilateral swap lines with other local and foreign banks (Prasado and Ye, 2007). Prasad and Ye conducted an evaluation in (2012) to determine the impact of the renmbi and the effect for the measures established by the government in internationalizing the currency. The authors established that there was a steep trajectory in each of the categories though the amounts were still modest. Nonetheless, the use of the renmibi had been extended to trade settlements particularly on the import side though generally, the dim sum bonds were narrow in scope especially among the financial institutions while mainland China was the key area of issuance. Furthermore, the authors noted that bilateral lines were not drawn upon. Nevertheless, the review established that China had a significant advantage in the sense that Hong Kong offered an efficient platform to launch such measures in a pilot manner without necessarily having to open a capital account. However, the authors observed that the notable developments could hit a snag if the capital accounts of China are more open.

There are so many questions that have been raised concerning the future of reserved currencies. Many observers have predicted an end to the dollars controlling the market. And therefore one of the Chinese aims is to establish renminbi as the most global reserved currency, despite the fact that the US dollar has overtaken the world as the best foreign money. The majority of people believed that the dollars outcome is almost sealed after the collapse of the United States housing market around the year 2007. It was the cause of the biggest disruption in the U.s monetary exchange market ever since the great depression.

The problem of the renminbi as a global reserve currency has broader consequences, as the changes in china's economy and its currency; it has many ramifications for the international macroeconomic and financial stability among the countries. Out of the world's money five biggest economies, China renminbi is the one that is not found in the reserve currency despite the fact that, the Chinese economy has flexible exchange rate and open capital account. The government has taken different initiatives to speed up the international use of the renminbi, something that has enabled China to gain traction and portend increase participation in the world trade and finance (Frankel, 2012)

The renminbi has started to appear in the reserve sets of some upcoming market as well as the growing economies. The agreement between China and Japan regarding currency is an indication that China is trying to minimize its dependence on the dollar. Whereas, other countries like the Asian countries are more eager to engage in such mutual agreements because they see advantages to very close trade and financial connection with China. This transformation that is more symbolic with the current substantive will create mass with time and have the capability to start changing the global monetary system(Prasad,2012).

The financial market advancement in the individual's country is one of the important aspects in determining the international currency status. Over the previous year, each reserve currency that has achieved the global currency status in different situations has been urged by diverse motivations. For example, a key determining factor of the United States dollar status as the most common global reserve currency is because of its financial markets. And this has remained incomparable in their scope, the level of financial instruments that is offered to foreign stockholders, the amount of every device and the standard of trading with those instruments. (Eichengreen, 2011). Ironically, due to inadequate safe assets that are provided by other economies, the increasing level of United States administration debt is strengthening the purpose of the dollar as the most leading reserve currency. This security would be a dream if the united stated situation becomes unbearable. Therefore so far business policies have planned to increase the offshore use of renminbi which is the centerpiece of china's currency internationalization process. While it has been the best way of promoting renminbi role in marketing exchange. And therefore its international use cannot be achieved without proper onshore enlargement

However, the idea of renminbis to act as the reserve currency has extended and lured many attentions this year, as an international monetary fund is establishing on how to review the exchange basket to determine the value of its asset. China has been over the last few years campaigning to have Renminbi counted in the basket together with US dollar, British pound and also Japanese yen. The fact that Chinese have pushed for reserve currency status for the renminbi is more of explicable.it s more of beneficial to the country .and it would make the country stable regarding money and minimize the need to hold immense reserves(Chinn, Menzie et al.,2008).

There have been claims by the international monetary fund regarding the current disruption in the exchange market that will not have any impact on the renminbi's possibility of being part of SDR basket. Even though, inclusion into the SDR basket is not enough for the renminbi to attain actual reserve –currency status. It is because SDR only accounts for 2% of total central bank reserves, and are not used by the private sector. More so the basket has not improved for the last fifteen years because it lacks its importance (Helleiner and Eric, 2009).But in some instances, it will be away from representing the milestone on the renminbi's way to its full internationalization. Something that will be difficult and requires a long way to go, the government will have to overcome all the challenges like extreme asset –price volatility in the process. At least, a reserve currency should be freely changeable for the recent account dealings like commercial trade and interest expenses. To also attain a clear reserve –currency status, it should also be freely exchangeable for capital -account r–solutions like the direct foreign investment.

Furthermore, the central banks need liquidity denominated in reserve currency to encounter balance of payment necessities, to check on debt and in most cases to get involved in the foreign exchange markets. For the country to attain all this, the nation's supplying the reserve currency require a massive domestic capital market particularly for short term and high-quality debt securities that central bank reserves can hold. In the United States of America, Treasury bills are meant for this role while in the United Kingdom there is an existence of the immense liquid pool of short term gilt. On the other hand, the Chinas debt market and the most likely source for reserve assets are too small and illiquid for central bank stand by managers. Away from maintaining convertibility, a nation must be willing to accept an excessive demand for its money and be able to distribute it freely. In another word this show that China will require to run a large listing current –account shortage. That probably it is not in a position to do so and at the same time some other nations will not be able to build claims against China that are not within the required viable reserve currency. Irrespective of how the Chinese government will be able to attain full convertibility and exchangeability for the renminbi, there is still no guarantee that it will for surely become a global reserve currency for the fact that reserve currencies are not that easily recognized. Definitely, for the last three centuries only three currencies have taken over that is; gold, British pound, Us dollar (Helleiner, Eric, 2009). However, Deutsche mark and Japanese yen have obtained feasible alternatives to the dollar ever since the Great War happened. Frequently, offering excellent stores of value that are more less exposed to the general increase in price. None of them has managed to be in the endless ways into the dollar share of global foreign exchange reserves. Perhaps China is in the process to put some measures to reach reserve currency status, and most probably it will be easier for the renminbi to be part of the SDR basket coming years. But as at the current market is showing, the way is full of many obstacles

Even if China is quickly growing and vitality are enormous advantages that will encourage the global use of its coins. It's very low level in financial market progression is a critical obstacle to its achieving the reserve currency status. It's so unfortunate that renminbi will become a dominant reserve currency, not only will it challenge the dollars in the exchange market but a competitiveness reserve currency within some few decades coming. With only minimal financial market development, it's easy to foretell that renminbi will be part of the basket of currencies that form the international monetary fund's distinctive drawing privileges (Helleiner, Eric, 2009)

The steady declined of the US dollar coupled with the sovereign debt crisis in the Eurozone have had little impact on the weight of currencies in the official reserves of central banks. However, the dominance of the Euro and dollar is soon ending as the Chinese Renminbi (RMB) is gradually taking over. In the recent years, authorities in China have put in place mechanisms to ensure that this dream is fulfilled through proactive strategies to increase international use of RMB. For instance, China in collaboration with foreign central banks has established a currency swap lines. Moreover, the country encourages its importers and exporters to transact in RMB. China is the second largest economy in terms of economic size and trade volumes. Yet, it is the only country among the top five biggest economies in the world that does not have a reserve currency.

If the recent events are anything to by, there has been growing concern about the role of the US dollar’s global dominance in the financial crisis. Some will argue that China’s Renminbi is ready to take over as an alternative to the US dollar. As trading currency then eventually as a reserve currency. This coupled with China’s economic weight and a large stock of foreign exchange transactions will establish the country as a geopolitical powerhouse. Murphy and Jin Yuan (2009) points out that China is ready to exercise larger say on the international financial system, through the introduction of its RMB. The country has in the recent years introduced RMB in transactions involving Chinese nationals or between the third-party countries, especially those that run a trade surplus to China would prefer RMB.

China’s monetary elite are aware of the risks of rushing to make RMB an international currency. As such, they are taking all the necessary precautions. For instance, the recent debate on whether the RMB poses a serious competition to the US dollar clearly outlined some of the limitations and risks for China. Plasschaert (2013), predicts that RMB has a long way to achieving the status the most used reserve currency. He suggests that China must first issue wide and diversified financial markets, so as the foreign central banks can be assured of their foreign exchange assets. Cohen (2012), is unconvinced of a fast RMB internationalization, considering China’s repressive financial environment. However, he is confident that with policy reforms in the country’s financial market development, capital account liberalization, and exchange rate flexibility would help in the adoption on RMB internationally.

China’s aggressive policy for internationalization of the RMB has responded to the risks and problems it faces. For instance, the country has designed an RMB-based trade policy via bilateral swap agreements to spread the international use of the currency. As a result, trade transactions involving the RMB have risen sharply to $350 billion as of 2012. According to Bank of International Settlement, Trading in the Chinese RMB, on the other hand, went up to $120 billion per day from $30 billion in 2010. Moreover, RMB moved to a ninth position in terms of the most traded currency in the world (BIS, 2013). The main reason for acceleration of internalization of RMB is the action by Federal Reserve accommodative policy to ease the quantities of money in the reserves which have inflated the country’s foreign exchange reserves. This, according to expert may result in accelerated inflation when large volumes of liquidity injected to boost the economy are not managed well once the economy stabilizes.

Three departments of the government in China that is the Ministry of Finance, the ministry of Commerce and the PBoC (People’s Bank of China), have spearheaded the internationalization of RMB. According to (Bell and Feng, 2013) party, leadership influences the rise of the PBoC. The year 2008 was a wake-up call for the bank, as it took a direct initiative to cushion the country from the economic crisis through diversifying the reserves and accelerating the international use of RMB. The SAFE (State Administration of Foreign Exchange), a department of PBoC in 2010 changed its investment strategy which has seen a great reduction of investment in the US Treasury bonds (Fidler et Alii, 2013). This strategy has seen a diversification of foreign investments that has included new reserves to balance the dollar, as a result improving the country’s returns on the foreign exchange reserves. The SAFE policy of going global has increased China’s financial power in the global market.

According to (Morrison and Labonte, 2012), the new policies included in these investment tools were designed to create an alternative to investment in US securities while drying up the flow of cheap capital traveling from Washington DC to Beijing. Speaking at EU-China Summit in 2011, Wen Jiabao, a former prime minister of China said it was time for the country to seek look for alternative investments to dollar-denominated assets. According to Jiabao, a Euro-denominated bond is one such alternative. China accounts for about 24% of the purchases for the EFSF (European Financial Stability Facility) bonds worth €13 billion. The second channel of diversification is the CIC (China Investment Corporation), established to manage China’s foreign exchange reserves. It is one of the largest sovereign wealth funds in the world. In 2012 it generated a 12.45 percent return on overseas investment.

In the year 2008, the PBoC established a policy in a bid to concluded currency swap agreement with six nations; the deal amounted to RMB 700 billion. The aim was to supply RMB to these nations and facilitate trade in case there was a shortage of US dollars. The short-term goal is to address the issue of liquidity as a means of sustaining the financial system. The idea was to promote trade and direct investment while driving the growth of the economy. The policy enabled the central bank to inject the swapped amount in a foreign currency into the domestic financial system. Which will then be borrowed by domestic commercial entities to pay for imports from other countries. Through the establishment of bilateral swap agreements, the PBoC is able to curb with the dependence of China and its trading patterns on the US dollars for settling of trade and invoicing.

The PBoC’s innovations reduce the risk of shocks and protect the Chinese exporters from currency risk. Through the removal or reducing the cost for hedging against foreign exchange risks the transaction cost of trade and investment. Influenced by the 2008 financial crisis, the PBoC began its bilateral currency swap agreement with New Zealand, South Korea, Belarus, Argentina, Malaysia, Iceland, Indonesia, and Singapore. Currently, the swap agreement stands at RMB 839.3 billion. The country is also in talks with Brazil and Russia about the swap currency agreement. Likewise, the use of RMB as an investment currency will eliminate the exchange rate risks to the Chinese companies seeking to borrow money for international investment. Liao and McDowell (2013) suggest that economic motivations, as opposed to geopolitical, are the reason behind internationalization of the RMB. For instance, the PBoC have moved to provide BSA liquidity to trade and investment due to increased dependence on trade and direct investment besides concerns over discontinued liquidity in the credit market.

Working as an independent sovereign financial method, the BSAs are important especially when international capital markets break down. These swap agreements have worked well to ensure that there is a constant supply of RMB to central banks of trade partners while accelerating the currency’s credentials as a viable reserve currency for central banks. Issuance of RMB-denominated bonds and settlement of trade transactions using the RMB by banks, and companies, in Hong Kong, denotes another channel of the internationalization of the RMB. Besides, the development of the offshore market for the RMB is PBoC program to evaluate the market view on the international use of the RMB while encouraging importers to pay with RMB through some of the liberalization measures. However, this strategy comes with its own fair share of risks, Cheung, Ma, and McCauley (2011) argue that the greatest risk that China faces internationalization of RMB without liberalization of the country’s capital accounts. China is still in the transition phase in its financial development.

Summary

To summarize from the above discussed the future development of renminbi as a global reserve currency, the conclusion that can be drawn is that there are significant conditions to be adhered to toward internationalization. Nonetheless, there so many challenges and obstacles like remains is not yet completely convertible, and there is also some restrictions on the capital and financial account, the growth of the country commercial market also need to be improved. And dollars, euros, yens, pounds and other important international currency are still the ones leading in the international currency system in the very short term due to currency inactivity. But due to a continuous economic development and country economic changes, contributions of the renminbi's among international reserve currencies will eventually increase in the long term. The Chinese government will have to open capital and financial account in each stage, supporting innovation and some reforms in the business market so that it can attain renminbi internationalization as fast as possible.

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