China has taken full advantage of regional willingness for RMB trade settlement and global hunger for Chinese assets to further RMB internationalization. However, much of the deregulation that has raised the RMB’s global position has been made under duress from international standards.
RMB internationalization is one of the most important symbols of China’s growing economic hegemony and has been a national priority. This is the first in a series of articles on RMB internationalization. This article discusses the RMB’s growing global role and the wins notched up so far.
Early Years
The RMB began its internationalization journey in June 2009 when the Peoples Bank of China (PBoC) implemented the pilot project on RMB trade settlement. The subsequent year laid the policy groundwork for internationalization – establishment of the offshore RMB (called CNH) market in Hong Kong, allowing of CNH deposits and deregulation of the ‘Dim Sum’ bond market for the investment of these offshore funds.
The early years showed enthusiastic adoption of RMB as it was expected to appreciate and everyone wanted to be at the receiving end. By the middle of the decade, RMB trade settlement peaked at 29% of China’s total trade, CNH deposits increased to nearly a trillion and Dim Sum bond issuance peaked at RMB300bn. To smooth liquidity shortages for countries using the currency, the PBoC established currency swap lines with more than thirty central banks. Clearing centres were opened globally to provide RMB settlement services with mainland entities.
Turning point
Global RMB sentiment hit a turning point after the exchange rate reform of August 2015 when the PBoC changed the method of calculating the RMB central parity to be based on the previous day’s closing value of the spot, thereby giving market forces greater influence. This resulted in a one-off RMB depreciation of 1.9%.
The worsening of RMB sentiment set in motion a two year long capital outflow estimated at USD460bn just by looking at the balancing item of net errors and omissions (NEO) in the Balance of Payments data, widely regarded as a gauge of capital flight. The PBoC lost more than USD400bn of FX reserves in the six months following the devaluation trying to shield the currency from depreciation pressures. Trade settlement and CNH deposits dropped to half of their peaks.
The Wins
Despite the slowdown in RMB internationalization by certain metrics such as slippage in its SWIFT rankings on cross border payments, the RMB has come a long way. After the RMB was included in the IMF’s basket of reserve currencies called the Special Drawing Rights (SDR) in 2016 many central banks included it in their FX reserves. Governments in Asia, Europe and Middle East have issued sovereign ‘Panda’ bonds denominated in RMB. Chinese stocks are now included in key global indices such as MSCI and its bonds have been included in the Bloomberg Barclays Global Aggregate Index.
The launch of the Cross Border Interbank Payments Systems (CIPS) in 2015 for international RMB settlement has simplified RMB clearing and settlement and will make offshore RMB clearing centres redundant over time.
One should, however, note that several reforms have been made under compulsion to achieve external objectives and not as a natural progression of deregulation. The opening of the China Interbank Bond Market (CIBM), removal of interest rate ceiling on deposits and the exchange rate reform of 2015 were all done to bolster the RMB’s case for SDR inclusion. Likewise, the launching of delivery-versus-payment and block trades for bond investments under the bond connect scheme were allowed after Bloomberg explicitly specified it as a pre-condition for the index inclusion of Chinese bonds.
To summarize, while China has taken full advantage of regional willingness for RMB trade settlement and global hunger for Chinese assets to further RMB internationalization, it has moved incrementally on financial market deregulation. This is due to the shallowness of its domestic financial markets which has made policy makers rely on exchange rate and capital controls. These are discussed in the next article in this series.
Macrologue 