Great power shifts are usually accompanied by changes in the international reserve currency. So it is telling that China is taking steps to broaden the use of the renminbi among international investors. Dominance of the global economy, Beijing believes, goes hand-in-and with dominance of the global monetary system.
Measures to internationalise the renminbi are nothing new. Hong Kong banks have offered offshore renminbi accounts for more than six years, and currency swap agreements with foreign central banks have been in place since 2000. But they have accelerated in recent months. Restrictions on offshore transfers have been eased and a programme allowing companies to settle cross-border trades in renminbi expanded. Last week's decision to open up domestic bond markets was particularly significant. Until then there were few investment opportunities for international holders of renminbi.
These are, however, only small steps. Whether China will be able to stomach the rest of the renminbi's journey to reserve currency status is far from clear.
A reserve renminbi would have to be fully convertible, on the capital account as well as the current account. But this would imply opening up China to the whims of global capital – precisely what it has been protecting itself against (as its huge foreign exchange reserves attest). Freer capital flows may also prove destabilising for domestic banks, creating liquidity bubbles in good times and choking off the credit supply as conditions deteriorate. No longer would the banking sector be an effective instrument of macroeconomic policy, as it has been during the crisis with its government-induced lending sprees. It would be a source of, and not a remedy to, increasing economic volatility.
Even less palatable for the government is the prospect of losing control over the renminbi. Maintaining a currency peg in the face of massive capital inflows is extremely difficult. And if increasing foreign demand for the renminbi pushes up its value, China's export-led growth model – which relies on an undervalued currency – may become unsustainable.
China will become the world's largest economy in the next few decades. It is natural that the renminbi eventually attains reserve currency status. China should not push this process forward prematurely, lest it destabilises its economy. But the sooner it starts the domestic reforms that will prepare it for such a shift, the easier it will find its new international role.
(Source: Financial Times)
(Image source: Ibtimes.com)
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