Will China’s Push to Internationalize the Renminbi Succeed?

Will China’s Push to Internationalize the Renminbi Succeed?
Will China’s Push to Internationalize the Renminbi Succeed?
Will China’s Push to Internationalize the Renminbi Succeed? Top

    There are nearly as many currencies in use around the world as there are countries, but only a handful of currencies are widely used outside of their home economies. These “internationalized” currencies facilitate international trade and finance, and as a result, serve as key pillars of economic influence.

    China’s renminbi (RMB) is one of many currencies traded by banks and other institutions within the global foreign exchange (forex) market. In 2019, more than $285 billion worth of renminbi was traded daily in the forex market.1 While seemingly massive, this amounts to just a fraction of the total value of currencies bought and sold in any given day.

    Trades involving the US dollar reached over $5.8 trillion per day in 2019, putting the dollar on one side of more than 88 percent of all forex transactions.2 The prevalence of the dollar has been a feature of the international economy for decades, and stems from the large size and relative stability of the US economy. Governments and businesses around the world look to the dollar as a safe store of value and as the best intermediary for transactions between less internationalized currencies.

    The US has garnered considerable economic and political clout from the dollar’s prominence in the global economy. The wide use of the dollar makes it more convenient for US companies to conduct business abroad while limiting their exposure to exchange rate fluctuations that can be both sudden and costly. It also means that US economic policy – especially actions taken by the US Federal Reserve – can affect the global economy.

    China’s emergence as a global economic power has only modestly boosted the standing of the renminbi internationally. Since 2001, China’s trade in goods has grown by more than a factor of nine, propelling the country to become the world’s single largest trader. The renminbi’s usage in forex trades expanded from effectively zero to 4.3 percent of all trades over the same period, but the renminbi remains the eighth most traded currency.

    Leading currencies almost exclusively belong to developed economies. The euro, which is used by hundreds of millions of people across 19 euro area countries, is the second most traded currency in the forex market, after the dollar. The yen is the third most exchanged currency in the world and by far the most used Asian currency, despite China boasting total trade values more than three times greater than those of Japan.

    Other economies with even smaller international trade footprints have currencies that lead the renminbi. The UK’s trade with the rest of the world is one-fourth that of China, yet the pound is exchanged three times more than the renminbi. Similarly, the combined value of Australia’s imports and exports is just one-tenth the size of China’s total trade, but the Australian dollar is the fifth most traded currency.

    Exchanges between these five currencies drive the majority of activity in the forex market. They accounted for nearly 57 percent of all trades in 2019. Exchanges between the dollar and the euro alone constituted 24 percent of all trading. Conversely, transactions between the renminbi and all other currencies accounted for just over 4 percent of all trading, with nearly all renminbi being exchanged for dollars.

    Tracking the World’s Top Currencies

    This interactive explores the relationship between economic size, trade value, and how major currencies stack up in the global foreign exchange (forex) market. Bubbles represent economies and are sized relative to GDP. Click a bubble or use the search bar to see detailed information. Switch between years to see change over time.

      Other measures of currency internationalization reflect a similar trend. Foreign exchange reserves, which serve as stores of value in foreign currency, are a key indicator of currency internationalization. Of the roughly $11 trillion in allocated foreign exchange reserves held by countries around the world in 2019, just under 2 percent were denominated in renminbi. While this marks an increase from just over 1 percent in 2016, growth has been slow.3 The vast majority of reserves remain in either US dollars (over 60 percent) or euros (around 20 percent).

      The renminbi has likewise gained only a modest foothold in international payments. Since the international payment network SWIFT began tracking the renminbi in 2011, usage of the currency in international payments expanded from just a quarter of a percent to a peak of nearly 2.8 percent in August 2015. The renminbi’s share declined slightly in the following years and has continued to hover around 2 percent.

      China’s Push to Internationalize the Renminbi

      Successful internationalization of the renminbi would offer China many of the same advantages that the US and other major currencies enjoy, such as lower borrowing costs and reduced exchange rate risk. Deeply internationalized currencies are, however, typically associated with open and liberalized economies. China’s economic system is different. Beijing maintains tight capital controls to buffer the Chinese economy against instability, but these restrictions also inhibit the free movement of the renminbi, making it less attractive as an international currency.

      Belt and Road Initiative

      China has long been accused of manipulating the renminbi exchange rate. How does the value of its currency benefit China? Learn more.

      Beijing has implemented broad economic reforms over the past several decades and renminbi internationalization has motivated some of these reforms. The 13th Five Year Plan (2016-2020) lays out a desire “to steadily promote RMB internationalization and see RMB capital go global” as part of broader financial and economic reforms. People’s Bank of China (PBOC) Governor Yi Gang reiterated this message in December 2018, when he stated that “renminbi internationalization is an inevitable trend and natural result” of economic reform. Yet, Chinese leaders have inconsistently pursued reforms, creating roadblocks to currency internationalization.

      A significantly internationalized renminbi would likely reduce the relative dominance of the US dollar and other internationalized currencies in the global economy. Chinese leaders have long worried that the US can use its economic clout to influence other countries. They have also expressed concerns that the dollar’s powerful position in the international monetary system poses a risk to global economic stability. China is not alone in this respect. European leaders have long complained that the US gains an “exorbitant privilege” from the dominance of the dollar. More recently, they have criticized the US for imposing unilateral sanctions on countries like Iran.

      In the wake of the 2008 global financial crisis, Chinese officials actively voiced their concerns. Without mentioning the dollar directly, then-Governor of the PBOC Zhou Xiaochuan criticized the existing international monetary system and called for establishing an international reserve currency “disconnected from economic conditions and sovereign interests of any single country.” China subsequently began more actively promoting the use of the renminbi abroad.

      The internationalization effort gained steam in July 2009 with a pilot scheme for renminbi trade settlement that included five cities in mainland China on one side of the arrangement and Hong Kong, Macau, and ASEAN members on the other. This marked the first-time renminbi settlements were permitted outside of mainland China.4 The pilot program was expanded in both 2010 and 2011 to include all of mainland China and partners across the globe.

      Offshore renminbi clearing centers soon took shape in several countries around the world. China’s cross-border trade settlement in renminbi exploded in the following years, from effectively zero in 2009 to RMB 1.63 trillion in the third quarter of 2019 alone. Renminbi clearing is nonetheless heavily concentrated in Hong Kong. In January 2020, 74.7 percent of all renminbi transactions were cleared in Hong Kong, well ahead of the UK (6.5 percent) and Singapore (3.5 percent).

      Currency Swap Agreements (2009-2020)
      Economy Number of Currency Swap Partners
      China 33
      United States 14
      Japan 12
      Euro Area 11
      Switzerland 8
      Source: Various central banks
      Based on number of partner economies, not agreements. Updated through March 2020.

      Promoting the use of the renminbi in international trade has been a critical part of renminbi internationalization efforts. China has had some success on this front by establishing bilateral currency swap agreements, which provide countries with access to foreign currency and reduce the risk of exchange rate fluctuations.5 Between January 2009 and March 2020, China signed currency swap agreements with a total of 33 other governments – more than any other country by a wide margin.

      These agreements have not only helped expand the use of the renminbi in trade, but also promoted a positive image of China abroad. Beijing concluded multiple currency swap agreements with Buenos Aires in 2014, providing Argentina with enough buying power to afford imports as the country reeled from a costly default on its international loans. Washington has signed its own swap agreements, often to promote dollar liquidity in global markets during international crises. In March 2020, the US Federal Reserve announced agreements with nine major counterparts to address the economic fallout precipitated by the worldwide outbreak of the novel coronavirus.6

      Beijing also undertook a series of reforms to advance the renminbi’s prospects for inclusion in the Special Drawing Rights (SDR) basket. The SDR is an international reserve asset created by the International Monetary Fund (IMF) to supplement IMF members’ international reserves. In order to be included in the SDR basket, a currency must be issued by a large exporter, a criterion China easily meets. Currencies must also be “freely usable,” a more subjective assessment based on forex trading and international usage.

      The addition of the renminbi to the SDR basket in October 2016 marked a major milestone for China, as it elevated the renminbi to a position alongside the dollar, euro, yen, and pound. The move also helped expand the renminbi’s presence in official foreign exchange reserves, but it was somewhat controversial given continued limits on renminbi usage outside China and the tightening of capital controls by China shortly after the decision.

      Currency Internationalization Comparison (2019)
      Currency Share of Official Forex Reserves (%) Share of Global Payments (%)
      US dollar 61.7 40.1
      Euro 20.3 34.2
      Yen 5.4 3.3
      Pound 4.6 7.1
      Renminbi 1.9 2.2
      Source: BIS; IMF; SWIFT
      Note: Forex trading based on April 2019. Forex reserves based on Q1 2019. Global Payments based on January 2019.

      China has undertaken several additional measures to better enable international usage of the renminbi. Dim sum bonds, for example, allow investors to purchase renminbi-denominated assets outside of mainland China, where they are subject to fewer restrictions. Since first appearing in 2007, the dim sum bond market has experienced large swings as a result of economic policy changes from Beijing.

      Other initiatives include allowing inward and outward foreign direct investment to be cleared in renminbi and establishing London as the biggest renminbi trading hub outside of China. The cumulative impact of these efforts has tangibly improved the renminbi’s international standing, but progress has been slow, and mixed policies from Beijing have cast uncertainty over the prospects of renminbi internationalization.

      Future Prospects of Renminbi Internationalization

      Renminbi internationalization began just over a decade ago, and its limited progress has come at a relatively low cost. Carving out a greater role for the renminbi in the global marketplace will require Chinese leaders to more aggressively pursue reforms and make difficult tradeoffs between the benefits of currency internationalization and the costs of loosening economic controls.

      Strict capital controls hinder the development of Chinese financial markets and restrict the movement of renminbi across the world. While Beijing has relaxed some controls on capital and the renminbi exchange rate, the country’s capital account remains one of the least open in the world. Liberalizing capital controls would allow for greater capital flows into and out of China, but it would also expose the Chinese economy (and the renminbi) to greater volatility. This is especially true given that the Chinese financial system remains underdeveloped.

      To forestall economic volatility, Beijing has favored a very gradual loosening of capital controls, often at the expense of greater renminbi internationalization. After China devalued the renminbi in August 2015, it was also compelled to tighten restrictions to avoid a rapid outflow of capital in anticipation of an even greater depreciation. The move was successful at staunching capital flight, but it greatly reduced international confidence in the renminbi, as well as the prospects for further liberalization. Cross-border settlement of renminbi fell sharply as a result, from an all-time high of RMB 2.09 trillion in the third quarter of 2015 to a three-year low of RMB 994 billion in the first quarter of 2017.

      Political concerns pose additional obstacles to renminbi internationalization. When widescale protests erupted across Hong Kong in the summer of 2019, the ensuing economic disruption contributed to a decline in the renminbi’s share of global payments. As the global center for renminbi clearing, Hong Kong plays a critical role in renminbi internationalization. Sustained political unrest within the Asian financial powerhouse could have a sizable effect on the global standing of the renminbi.

      Establishing an international financial center elsewhere could help alleviate these risks. To this end, China established the Shanghai Free Trade Zone (FTZ) in 2013. While Chinese officials claim the FTZ has made advances toward transforming the city into a financial hub, concerns about the health of the Chinese financial system remain serious obstacles to long-term success.

      It is also difficult to displace established currency leaders. The dollar – and to a lesser extent the euro – are already deeply ingrained within the existing international trade and monetary systems. As a relative newcomer to the international scene, the renminbi will have to gain the confidence of investors, businesses, and governments before it can expand its international standing.

      Japan’s unsuccessful efforts to further internationalize the yen help demonstrate the challenges that may lie ahead for the renminbi. In the wake of the 1997 Asian financial crisis, Tokyo began to actively promote the internationalization of the yen, especially within Asia. The campaign ultimately failed, due largely to economic and financial stagnation within Japan and the overwhelming dominance of the dollar in Asia.

      Some signs suggest the renminbi may succeed where the yen failed. During Tokyo’s push to increase international use of the yen, the currency’s share of official forex reserves actually declined, albeit slightly, from 2001 to 2016. Conversely, a majority of central bank reserve managers anticipate that the renminbi will account for 10–20 percent of global reserves by 2030, a noteworthy rise from its current standing of just under 2 percent.

      Number of Banks Using CIPS in Select Economies (2019)
      Economy Number of Banks
      Japan 30
      Russia 23
      Taiwan 19
      Singapore 16
      UK 15
      Source: Nikkei
      Figures updated through April 2019. Excludes mainland China, Hong Kong, and Macau.

      China is also achieving some success at boosting usage of the renminbi through its Cross-border Interbank Payment System (CIPS). Beijing introduced CIPS in October 2015 as an alternative to SWIFT, which currently processes the lion’s share of international payments. CIPS handled roughly RMB 26 trillion worth of payments in 2018, marking an increase of over 80 percent from 2017.

      The initial success of CIPS has largely been driven by its use in countries associated with China’s Belt and Road Initiative (BRI), which suggests that Xi Jinping’s flagship foreign policy program is already contributing to renminbi internationalization. As recently as 2017, Chinese officials acknowledged that there were more than 50 BRI-linked economies in which the proportion of renminbi usage in cross-border transactions was below 5 percent. Stronger economic ties between China and BRI countries could propel the renminbi to become the currency of choice for many BRI economies.

      Prioritizing renminbi internationalization will require Beijing to make serious commitments to economic reforms that could expose the country to greater financial instability. A concerted effort by Chinese leaders will be needed to boost the presence of the renminbi within forex reserves and international trade. Even with the weight of the world’s second-largest economy behind it, China will face an uphill battle in advancing the renminbi’s position within the global currency hierarchy. ChinaPower