T

he use of the RMB (renminbi) as international money indicates the readiness of the People'€™s Republic of China (PRC) to take a greater role in managing the global economy. The increasing use of RMB as a store of value shows the trust of the international community in its stability as a safe asset and confidence in its future role in the international monetary system.

The PRC is now the second largest economy, after the US, with a large share of global trade and huge foreign exchange reserves. Because of this, the RMB has been used by its trading partners as a medium of exchange and a unit of account for pricing and settlement of bilateral trade with the PRC.

The use of the RMB in regional trade is rapidly increasing after the authorities in the PRC allowed a number of domestic enterprises in selected cities to settle trade in RMB.

Imports are increasingly settled in reminbi but exports are still mainly settled in the US dollar. Starting from a small amount, a number of countries, such as Belarus, Cambodia, Malaysia, Nigeria, the Philippines, Korea, Chile and Russia, have been holding RMB in their international reserves as an insurance against balance of payment pressures.

ASEAN has become a de facto RMB bloc and gradually countries in this region have used the RMB as a reference point to determine the external value of their currencies, eclipsing the US dollar and the euro (Subramanian and Kessler, 2013). Trade between the PRC and ASEAN rapidly increased after the establishment of CAFTA (China-ASEAN Free Trade Area), which came into effect in January 2010.

Stronger economic links in East Asia have been reinforced by the international production networks of the multinational companies that encouraged intra-industry trade in this region. Traditionally, ASEAN countries are suppliers of raw materials for manufacturing industries in the PRC, as well as a market for its exports. The global supply change that breaks up the production process into geographically separated stages has increased exports of industrial spare parts and components from ASEAN to the PRC.

Personal use of the RMB is encouraged by allowing financial institutions in Hong Kong to open renminbi denominated accounts and for use in cross-border settlements, including sending remittances to mainland China. On a limited basis, the authorities in the PRC allowed some domestic banks to issue renminbi-denominated bonds, popularly known as dim sum bonds and panda bonds, in Hong Kong in June 2007.

This allows Chinese banks and companies to tap low-cost financing in international markets without exchange rate risk. The issuers are gradually expanding to non-bank companies and to other jurisdictions, such as Singapore.

The PRC and Japan have now become important providers of liquidity support to central banks in many emerging economies in the ASEAN+3 region during times of crisis. In addition, the PRC has a more important role as a provider of development aid and finance.

Together with the four BRICS countries (Brazil, India, Russia and South Africa), China recently established a new BRICS development bank with its headquarters located in Shanghai. Jointly with some other countries, in October 2013, the PRC announced the creation of the Asian Infrastructure Investment Bank (AIIB) to build badly needed infrastructure in Asia and the Pacific.

The establishment of the AIIB is a welcome initiative given the declining lending capabilities of the World Bank and ADB after the global financial crisis in 2008-2009. The building of infrastructure projects provides fiscal stimulus for the stagnated world economy.

Under the Chiang Mai Agreement (CMI) of 2000, the ASEAN+3 countries established swap arrangements to provide liquidity support for member countries experiencing short-run balance of payment deficits. The objective of this initiative was to prevent crisis and systemic failure in a country and subsequent regional contagion, as occurred in the Asian Financial crisis in 1997.

The CMI has two components, namely: (i) a network of bilateral swap and repurchase arrangements (BSA), which is an expansion of the ASEAN Swap Arrangement of 1977, and (ii) the multilateral swap arrangements of 2008. The multilateralization of the CMI is a great leap forward in traditionally less politically cohesive ASEAN+3 countries as they transfer some of their national powers to a regional supranational authority, namely, the Chiang Mai Initiative Multilateralization (CMIM).

The benefits and costs of the internationalization of the RMB to the Chinese economy

The benefits include lower transaction costs because foreign trade and investment are done in the domestic currency and hence eliminate exchange rate risk. The country enjoys the international seignior age, which is the difference between the face or nominal value of the currency and its cost of production.

The issuing country enjoys inflationary tax as inflation rates erode the real value of the currency. Internationalization of the RMB allows the PRC to provide low-cost financing in international markets with liabilities denominated in that currency without exchange rate risk. Issuing international bonds makes domestic interest rates more dependent on interest rates in the international market.

Making the RMB a reserve currency, or an international store of value, in my opinion, is a long-term goal. A number of policies should be taken to make it happen. First, end rigid capital control and make the RMB tradable in international financial markets. At present, the RMB is not a convertible currency.

To make the RMB convertible, the government needs to remove restrictions on capital flows to open capital account. Government interventions should be reduced in the thin foreign exchange and financial markets.

Limited capital restrictions can only be used as a macro prudential policy to deter speculative attacks.

Second, adopt a flexible exchange rate system and allow market forces to determine the external value of the RMB. This requires the end of the current fixed exchange rate policy and the use of it to promote exports, restrict imports and to reallocate resources from the non-traded sector to a traded one in the domestic economy.

Third, liberalize monetary and credit policies and move toward market-based policies. At present, in terms of asset and branch networks, the financial system of the PRC is still dominated by state-owned banks with limited competition.

Fourth, improve the legal system and rule of law as a way to improve market efficiency and hence reduce the cost of market transactions. An efficient legal system should protect property rights and enforce business contracts.

Fifth, give independent status to the central bank in order to achieve its short-run stabilization objective of controlling the inflation rate.

This should be supported by a flexible exchange rate policy and sustainable fiscal and debt rules in the public sector.

Sixth, develop liquid, deregulated and open financial markets with a wide range and large volume of financial assets and high level of turnover. With a limited private equity market in a socialist PRC, the financial instrument is dominated by the government debt market either issued by the central government, or provincial and local governments, or state-owned banks and enterprises.