Policymakers in Beijing must be feeling warm and fuzzy these days. For years, they have railed against the dominance of the U.S. dollar in global trade and finance, complaining that it leaves the world at the mercy of erratic Washington politics and questionable economic management. China’s leaders can only blame themselves for their heavy reliance on the dollar, but still, from Beijing’s perspective, a world in which China’s own currency — the renminbi — is a more potent force would be a more stable one for the country’s development.
Thus the recent news about how popular the yuan is becoming must be heartening. Earlier this year, a survey from the Bank for International Settlements showed that the renminbi entered the list of top 10 most traded currencies for the first time. And in early December, a report from financial-services firm SWIFT revealed that the renminbi had overtaken the euro as the second most used currency in global trade finance, with its share jumping from a mere 1.89% in January 2012 to a more respectable 8.66% in October.
But Beijing shouldn’t uncork the champagne bottles just yet. The same SWIFT report details just how far the renminbi still has to go to become a truly international currency. Nearly all the trade finance conducted in yuan was undertaken by businesses in China, Hong Kong and Singapore, showing that its use remains extremely limited. The dollar is the currency of choice in 81% of the world’s trade finance, according to the SWIFT study. Nor has the renminbi gained much stature among the world’s central bankers, who still prefer the dollar and euro. Central banks in countries as diverse as Chile, Nigeria and Malaysia have reported holding yuan in their portfolios, but its use as a reserve currency is overall infinitesimal.
The hurdle facing the renminbi is both simple and not simple. Despite China’s global clout in manufacturing and exports, in international finance it remains a bit player. That’s because the government still imposes strict barriers between China’s financial sector and capital markets and those of the rest of the world. Controls restrict how money flows in and out of the country. Foreign investors cannot freely invest in yuan-denominated assets. The value of the yuan is still heavily influenced by the government, and it is not permitted to trade freely. If global investors, bankers and businessmen are to have the confidence in the yuan necessary to elevate its status, China will have to clear these restrictions away and give more power to the market in determining the worth of the yuan and its flow in and out of the country.
That’s easier said than done. China’s policymakers have been talking up a storm for years about internationalizing the renminbi, but progress has been glacial. Still, over the past few weeks, the promises of reform have become bolder and more specific. In early December, they took some important steps when the People’s Bank of China, the country’s central bank, issued guidelines on experimental capital flows to take place in a new Shanghai free-trade zone (FTZ), launched in September.
New types of bank accounts will be permitted in the FTZ that can be used to move money more freely in and out of the international financial market. Foreign investors operating in the zone will be able to invest without the usual restrictions in the stock market in Shanghai, and Chinese will be better able to invest overseas. Calling the guidelines “bolder than expected,” HSBC economists Qu Hongbin and Ma Xiaoping asserted that they “suggest a marked acceleration in capital-account liberalization.”
Such steps are aimed at experimenting with the sort of open flows of money that could, when implemented on a national scale, help the renminbi become a major international currency. But there are clear limits to how far the central bank is willing to go. There appears to be little concrete movement on allowing the yuan to be valued in a more market-oriented fashion. It also appears that the zone will be walled off from the rest of China — so the experiments there don’t impact the wider economy. In other words, change will be slow, carefully monitored and confined to a certain group of individuals and institutions.
To a certain degree, that makes sense. Throwing open China’s insulated, inexperienced and ill-equipped financial sector to free capital flows and more foreign competition could be disastrous. But at the same time, going too slowly will keep Chinese banks, financial markets — and, yes, the renminbi — stunted and their international sway limited. Figuring out how quickly to proceed will be one of the biggest challenges facing China’s policymakers over the next decade. Until then, the renminbi’s dollar dreams will have to wait.