Blog Post

Reform needed before Chinese currency joins top league

The internationalisation of the Chinese currency is progressing but substantial reform is needed before it can reach the same standing as the euro or dollar.

By: Date: March 21, 2012 Topic: Global Economics & Governance

China is often at the heart of debates about the world economy but the discussion essentially revolves around two topics. One is the valuation and the flexibility of the exchange rate. The other is external imbalances, reserves and the degree to which they can destabilise the world economy. Both largely ignore the place of China in the international monetary system, and the role that its currency can play in it. Following a report on the latter, the Bruegel think-tank has focused on the ongoing evolution of the renminbi and its current path towards internationalisation. Its findings suggest that the Chinese currency could challenge pound sterling or the Swiss franc in the near future, but increasing its prominence to challenge that of the euro or the dollar is a longer-term endeavour that will require substantial reforms.

Most of the literature on the matter argues that the RMB’s potential as an international currency is limited so long as China maintains a largely closed financial account, its exchange rate remains managed, and its financial sector remains state controlled and closed to foreign participation. This argument is largely based on the so-called ‘impossible trinity’ – the theory that it is not possible to have a fixed exchange rate, free capital movement, and an independent monetary policy all at the same time – but fails to take into account the cracks that China’s policy can open in the traditional Mundell-Fleming stylised fact.

An analysis of the processes through which the RMB is starting its internationalisation shows that its path largely allows it to circumvent capital account restrictions. And, while the net creditor position of China could substantially slow the internationalisation process, there is an active strategy to encourage international investments by corporates which ought to gradually rebalance China’s net investment position. The creation of the RMB offshore market is an important step in this development and allows the insulation of the domestic financial system, thereby circumventing financial account restrictions. Second, the managed nature of the exchange rate does not really preclude a degree of internationalisation and, in any case, currency flexibility will follow relaxation of the capital account rather than the other way around.

Finally, the argument about financial sector liberalisation is often used in a self-serving and misleading way. China has decided to largely outsource this function to the offshore financial system in order to allow more time for its own fragile domestic financial system to adapt. In this context, one should see the offshore RMB market – which is primarily located in Hong Kong but likely to extend to other financial centres such as Singapore or even London – as a proxy Chinese financial sector and as a levee to prevent uncontrolled capital flows in mainland China, which have proven to be the source of financial crises in other emerging economies.

All in all, the usual obstacles brought forward by the economic literature on the matter are manageable. But there are challenges for the renminbi before it can obtain the status of the euro and the dollar. The first one is regional in nature because it is unclear yet whether China would like to use the regional role of the RMB as a stepping-stone towards its establishment as an international currency, or whether it can afford to leapfrog this step. The experience of the euro area provides both a model and a test case.

A version of this column was also published by Public Service Europe.

The Working Paper The internationalisation path of the renminbi is available here


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read about event More on this topic

Upcoming Event

Jun
24
08:30

China’s investment in Africa: consequences for Europe

How is Chinese investment impacting Africa, and what could be the consequences for Europe?

Speakers: Solange Chatelard, Maria Demertzis, Alicia García-Herrero and Abraham Liu Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF More on this topic

Working Paper

China and the world trade organisation: towards a better fit

China’s participation in the WTO has been anything but smooth, as its self-proclaimed socialist market economy system has alienated its trading partners. The WTO needs to translate some of its implicit legal understanding into explicit treaty language, in order to retain its principles while accommodating China.

By: Petros C. Mavroidis and André Sapir Topic: Global Economics & Governance Date: June 13, 2019
Read about event More on this topic

Upcoming Event

Jul
12
09:30

The 4th industrial revolution: opportunities and challenges for Europe and China

What is the current status of EU-China relations concerning innovation, and what might their future look like?

Speakers: Elżbieta Bieńkowska, Chen Dongxiao, Eric Cornuel, Ding Yuan, Jiang Jianqing, Pascal Lamy, Li Mingjun, Signe Ratso, Reinhilde Veugelers, Wang Hongjian, Guntram B. Wolff and Xu Bin Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Opinion

Too crowded bets on “7” for USDCNY could be dangerous

The Chinese yuan has been under pressure in recent days due to the slowing economy and, more importantly, the escalating trade war with the US. While the Peoples Bank of China has never said it will safeguard the dollar-yuan exchange rate against any particular level, many analysts have treated '7' as a magic number and heated debates have begun over whether the number is unbreakable.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: June 6, 2019
Read article More on this topic More by this author

Blog Post

The 'seven' ceiling: China's yuan in trade talks

Investors and the public have been looking at the renminbi with caution after the Trump administration threatened to increase duties on countries that intervene in the markets to devalue/undervalue their currency relative to the dollar. The fear is that China could weaponise its currency following the further increase in tariffs imposed by the United States in early May. What is the likelihood of this happening and what would be the consequences for the existing tensions with the United States, as well as for the global economy?

By: Inês Goncalves Raposo Topic: Global Economics & Governance Date: June 3, 2019
Read article More on this topic More by this author

Opinion

Expect a U-shape for China’s current account

As the US aims to reduce it's bilateral trade deficit, China's current-account surplus is back in the headlines. However, in reality China’s current-account surplus has significantly dropped since the 2007-08 global financial crisis. In this opinion piece, Alicia García-Herrero discusses whether we should expect a structural deficit or a renewed surplus for China's current-account.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: May 28, 2019
Read article Download PDF More on this topic

External Publication

Europe – the global centre for excellent research

This report, requested by the European Parliament's Committee on Industry, Research and Energy, analyses the EU’s potential to be a global centre of excellence for research as a driver of its future growth in a complex global S&T landscape, and how EU public resources can contribute to this.

By: Michael Baltensperger and Reinhilde Veugelers Topic: Innovation & Competition Policy Date: May 22, 2019
Read article More on this topic

Blog Post

India in 2024: Narendra Modi once more, but to what end?

Even with the recent economic slowdown, India still boasts Asia’s fastest growing economy in 2018. But beneath the veneer of impressive GDP expansion, uneasiness about India’s economic model clearly tempers enthusiasm.

By: Alicia García-Herrero and Trinh Nguyen Topic: Global Economics & Governance Date: May 17, 2019
Read article More on this topic More by this author

Blog Post

What is in store for the EU’s trade relationship with the US ?

If faced with a resurgent President Trump after the next US election, the EU will have some difficult decisions to make as it is compelled to enter a one-sided negotiation. Failure to strike a deal will imperil the world’s largest trade relationship and contribute to the progressive unravelling of the rules enshrined in the World Trade Organization – although the changes required of Europe by Trump’s demands may ultimately turn out to be in the interest of Europeans.

By: Uri Dadush Topic: Global Economics & Governance Date: May 16, 2019
Read article More on this topic More by this author

Podcast

Podcast

Director's Cut: Evolution of US-China relations amid trade-tariff conflict

Bruegel director Guntram Wolff and Bruegel fellow Uri Dadush welcome William Alan Reinsch, senior adviser and Scholl chair in international business at the Center for Strategic and International Studies, for a discussion of how China-US relations are developing in the context of unfolding trade war.

By: The Sound of Economics Topic: Global Economics & Governance Date: May 14, 2019
Read article More on this topic More by this author

Blog Post

Implications of the escalating China-US trade dispute

If allowed to escalate, the trade dispute between China and the United States will significantly increase the likelihood of a global protectionist surge and a collapse in the rules-based international trading system. Here the author assesses the specific impacts on the Chinese and US economies, as well as the strategic problems this dispute poses for Europe.

By: Uri Dadush Topic: Global Economics & Governance Date: May 14, 2019
Read article More on this topic

Opinion

Will China’s trade war with the US end like that of Japan in the 1980s?

The outcome of the US-China trade war is anticipated to be quite different from the experience of Japan in the 1980s and 1990s, due to China’s relatively lower dependence on the US and having learned from the Japanese experience.

By: Alicia García-Herrero and Kohei Iwahara Topic: Global Economics & Governance Date: May 13, 2019
Load more posts