China’s economy has grown to be a global powerhouse, and the yuan is the
ninth most traded currencyin the world. But China has some way to go before its currency is fully internationalized.
It announced two steps recently that again prompted chatter about the country taking steps to internationalize its currency.
First, the European Central Bank and the People’s Bank of China signed a 350-billion-yuan (€45 billion) bilateral currency swap agreement. The agreement is in place for three years and can be extended.
China has made a few such moves to make its currency fully convertible. It signed 100 billion yuan currency swap agreement with Indonesia earlier this month, reports Xinhua. And in September it signed currency swap agreements with Hungary and Albania.
Second, the People’s Bank of China also announced that it will allow foreigners to invest their offshore renminbi in domestic financial institutions. This would include investing in “new set-ups, additional investment, M&A, liquidation, equity sell-off, and profit remittances (outflows),” according to Stephen Schwartz, chief economist for Asia, at BBVA.
We’ve previously pointed out that China set up the offshore renminbi market so its currency could be used in the international market to settle trade and financial transactions without fully opening up its capital account.
So is this worth getting excited about?
Not quite. It’s good for China to set up these facilities, Patrick Chovanec, chief strategist at Silvercrest Asset Management, told Business Insider, but for the renminbi to be a truly international currency “its relationship to the global economy has to change in a fundamental way:”
“The problem is that China is not a net exporter of currency, China is a net importer of currency. This isn’t just related to the swaps, this is related to the bigger question of the international role of the renminbi.
“For the renminbi to be a truly international currency, it has to circulate outside of China, and it has to circulate on a fairly accessible basis. But if there are only a handful of countries in the world that are in a position to earn renminbi, and China is a net importer of currencies on the current account, and previously on the capital account, how is China going to become a net exporter of currency? How is that currency going to circulate? It implies a very different relationship with the global economy. ”
The flow of currency is what matters in terms of the Renminbi’s international use.
Chovanec points out that there was much chatter about allowing for currency convertibility in the Shanghai Free Trade Zone but officials backed away from it. This because allowing it in Shanghai would mean losing control of the domestic interest rates or exchange rate.
Also, if they tried to limit this to just Shanghai, this would mean there would be difference in the interest rate or exchange rate in Shanghai and the rest of the country, and that this would create “massive arbitrage opportunities.”
So, China would have to significantly open up its financial system, and while we have seen a flurry of financial reforms this year, there is a lot more to be done.
For China to be a fully convertible currency, it would have to be accessible for anything, anywhere. There have to be a wider number of countries willing to accept it. “The renminbi is a long way from that being the case,” says Chovanec.
Chinese officials have previously said they want to make the currency fully convertible by 2015.