WILL CHINESE YUAN BECOME
China’s economy is the 2nd largest in the world
Of the currencies of the world’s six largest economies, China’s
Renminbi or Chinese Yuan is the only one without reserve
Economy has neither a flexible exchange rate nor an open capital
Three aspects of the RMB’s role in IMS:
a. Currency Internationalization
b. Currency Convertibility
c. Principal Reverse Currency Status
Internationalization: its use in denominating and
settling cross-border trade and financial transactions,
that is, its use as an international medium of exchange.
Capital account convertibility: the country’s level of
restrictions on inflows and outflows of financial capital.
A fully open capital account has no restrictions.
Reserve currency: whether the renminbi is held by
foreign central banks as protection against balance of
China is promoting the international use of its currency by:
a. Permitting the settlement of trade transactions with the
b. Easing restrictions on cross-border remittances of the
Renminbi for settlement.
c. Allowing the issuance of Renminbi-denominated bonds in
Hong Kong and by foreigners in the Mainland.
d. Permitting selected banks to offer offshore Renminbi deposit
e. Setting up local currency bilateral swap lines with other central
CRITICAL FACTORS THAT UNDERPIN A
Open capital account
Flexible exchange rate
Financial market development
China now accounts for:
a. 10% of the world gross domestic product (15% by PPP rather than market
b. Nearly 9% of the foreign direct investment
c. > 10% of the world trade
o Open Capital Account:
China is gradually and selectively easing restrictions on both inflows and
a. The limit of foreign exchange purchases by residents for remittance abroad for
personal reasons was increased to $50000 a year.
b. More recently, the government has been encouraging outflows by institutional
investors (e.g., pension funds and insurance companies) and corporations.
c. Controls on inflows are also being gradually eased, although with many
restrictions still in place.
d. The upper limit on portfolio investments by individual Qualified Foreign
Institutional Investors has been raised but still remains at a modest $1 billion,
and the period for which these investments are “locked up” has been reduced.
Flexible Exchange rate:
a. Reserve currencies generally trade freely, and their external value is
b.China follows a quasi-pegged exchange rate and manages capital
Financial market Development:
a. China has relatively shallow and underdeveloped government and
corporate bond markets.
b. Inorder to establish Yuan as a reserve currency it also has to
strengthen its foreign exchange and derivatives market.
a. Investors in a country’s sovereign assets must have faith in its
commitment to low inflation and sustainable levels of public debt.
b. China has a lower ratio of explicit public debt to GDP than most major
reserve currency economies and has maintained moderate inflation in
EVALUATING CHINA’S GLOBAL CURRENCY
Financial market development in the home country is one of the key
determinants of a currency’s international status.
The relevant aspects of financial market development are the
a. Breadth: the availability of a broad range of financial instruments,
including markets for hedging risk;
b.Depth: a large volume of financial instruments in specific markets;
c. Liquidity: a high level of turnover (trading volume).
China falls short on many key dimensions of financial market
development, and its steps to aggressively promote its currency’s
international role are likely to be impeded over the medium term by
the weaknesses of its financial system.
China’s financial system remains bank-dominated, with the state
directly controlling most of the banking system.
REASONS WHY YUAN WON’T REPLACE DOLLAR’S:
Money Talk is not enough:
Dollar’s holds 62% of the world’s aggregated reserve
currency. Most of the central banks in other countries hold
a lot of dollars for the capital market.
The lack of transparency will be the main drawback
against the Yuan. Stability is the biggest factor why
countries gravitate to the dollar, which has not been
The Yuan, on the other hand, is tightly controlled by China,
even as Western countries led by the US call for more
liberalization of the Yuan.
REASONS WHY YUAN WON’T REPLACE DOLLAR’S
The Yuan is already being traded directly between China and
two other countries: Australia and Japan. That means, both
countries do not need US dollars to trade with China.
Does it mean the Yuan is gradually encroaching into the
dollar reserves of other countries? Yes and no. The
encroaching only goes as far as the bilateral trade between
China and that other country.
In world trade, the US will exert friendly pressure to maintain
the dollar as the exchange currency, and the rest of the world
other than perhaps North Korea, Iran, and China will not