The renminbi’s (RMB) potential as a global currency is huge and Chinese authorities will make steady progress towards making it a reserve currency, but the longer it takes to reduce the bias against foreign participating in China’s markets, the more likely the RMB is to remain a regional reserve currency, according to ABN AMRO.
“China’s growing economic importance – already the second largest economy in the world, accounting for more than 10% of global trade, with strong growth prospects and increasing global linkages – suggests that the RMB will some day become a reserve currency,” said Maritza Cabezas, economist at the bank.
But recently expectations that the RMB will continue to appreciate have weakened, and the process of internationalisation of the Chinese currency has lost some momentum. Cabezas argues that in order for China to achieve its aim, it needs to provide more clarity on regulatory and policy conditions.
“There are still a lot of unknowns regarding the pace of internationalisation, given that it is up to authorities to determine the scope and timing of regulatory changes,” she said.
In order for a currency to qualify as an international currency, it must fulfill certain prerequisites. While the size of the economy is certainly a factor, as well as the depth and liquidity of the capital markets, it is also crucial that the economy is open.
“It’s also important that there be no restrictions to cross-border transfers of funds or on third-party use of the currency in contracts and settlements of trades in goods or assets denominated in the currency,” said Cabezas.
In addition the internationalisation of the RMB is still in its early stages, and has been promoted as part of a more general agenda which includes capital account liberalisation and attempts to secure Shanghai’s status as an international financial centre.
“Chinese authorities have opted for a gradual approach to the RMB internationalistion. Most progress has been made in trade settlements, but progress in the liberalisation of the capital account is still minor, suggesting that the status of reserve currency is not part of the near term horizon,” said Cabezas.
China still exercises heavy control over its capital account, which Cabezas argues is a major impediment in the process of full currency internationalisation. While the dim sum bond market has offered an opportunity for international holders of the currency to invest in RMB denominated bonds, much more needs to be done to expand investment opportunities.
“Other measures which are still pending and would support this process include interest rate liberalisation and a more flexible exchange rate regime,” she said.
Taking these factors into account, she argues that the dollar will remain the most widely used currency in the world, at least during the foreseeable future, though at some stage she expects this to change. It may be replaced by the RMB, or even by the Brazilian real, the Indian rupee or the Russian ruble.
“Other emerging market countries could have potential for joining the global currency stage. Emerging markets already account for roughly half of global GDP. Brazil, India and Russia could be candidates, given their significant regional importance and growing weight in the world economy. Capital accounts liberalisation is also progressing in Brazil and Russia,” she said.