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Keeping Pace With the Economy
Balancing RMB internationalization
By Lan Xinzhen | NO. 31 JULY 30, 2015

 
RMB internationalization has once again come into the spotlight. During the seventh round of the China-U.S. Strategic and Economic Dialogue held in June, in-depth discussions were held concerning the incorporation of the Chinese currency in the International Monetary Fund's special drawing right (SDR) currency basket. It was promised that further discussions would follow in the upcoming SDR review.

The internationalization of the RMB is a long-cherished target of China and being included in the SDR basket will mark a milestone in the process of achieving this end. Nevertheless, China will not bend to any conceivable demand merely for the sake of SDR inclusion, as the internationalization of the RMB must not come at the cost of the country's economic development.

How can risks be effectively kept under control? The key is to keep the internationalization of the RMB in pace with the overall internationalization of the Chinese economy. The defining feature of an international currency is free convertibility. Within an economy that is not fully internationalized, the free convertibility of its currency could incur huge risks. Once given institutions choose to bet against this currency, namely "short" it, there is little if anything the country issuing the currency will be able to do to counter these speculators. This could deliver a deadly blow to the country's economy. China has been slow in opening free convertibility under the capital account owing to these very concerns.

If a country's economy is highly internationalized, it will be equipped with sufficient capital and capability to cope with such crises. Just how internationalized an economy is can be inferred from three respects: foreign trade, the use of foreign capital and outbound investment. The higher the proportion of the three to a country's GDP, the more internationalized that country's economy is and the more closely its currency is related to the global liquidity system.

As far as China is concerned, the total value of the country's international trade reached 26.43 trillion yuan ($4.2 trillion) in 2014. Its actual use of foreign capital amounted to 736.4 billion yuan ($120 billion). Its non-financial direct outbound investment reached 632 billion yuan ($100 billion). China's GDP in 2014 stood at 63 trillion yuan ($10 trillion). The aforementioned data can help one deduce that the internationalization level of the Chinese economy is 43 percent, falling far short of the 90 percent or thereabouts possessed by the economies of the United States, the European Union and Japan.

Nowadays, the RMB is being more extensively used in the international market. According to a report by the Society for Worldwide Interbank Financial Telecommunications (SWIFT), 1,081 financial institutions had begun to use the RMB as the currency of payment while trading with China by May 2015. RMB transactions accounted for 35 percent of currency payment in China's trade with these institutions, compared to 29 percent in 2013. In May, the RMB ranked fifth in the world as a global currency of payment, sharing 2.18 percent of the global market.

The report by SWIFT also reveals that use of the RMB among financial institutions has increased 22 percent compared with 2013. The proportion of financial institutions in the Asia-Pacific region using the currency has increased from 33 percent to 37 percent in the last two years. Among U.S. financial institutions, that figure grew from 10 percent to 37 percent during the same period. The fact that more international financial institutions have begun to use the RMB as a currency for payment is one of the important signs of progress in the RMB's internationalization. Thanks to these promising signs, more financial institutions will probably become interested in entering the cross-border interbank payment system that China is planning to launch before the end of the year.

The report implies that the RMB has already been equipped with the tangible functions of an international currency and that only one last vital step remains: enabling its free convertibility under the capital account. However, owing to the low internationalization level of the Chinese economy, it will take some time before this goal can be achieved.

The RMB's transformation into an international currency should not be seen as an end in and of itself, but as a by-product arising from the continual growth of China's real economy and its integration into the global economy. The RMB is expected to be more frequently used in the international market while China continues to expand its foreign trade, strives to make more efficient use of foreign capital and increases its outbound investment. Against the background of the ongoing internationalization of China's economy in addition to the financial and economic stability guaranteed by successful financial reforms, it will be only natural for the RMB to, with the passage of time, become an international currency in the real sense of them.

Copyedited by Eric Daly

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