Comment on “The Boom and Bust of the RMB's Internationalization: A Perspective from Cross‐Border Arbitrage”

Abstract

Zhang and Zhang (2017) assess the achievements and prospects of the Renminbi (RMB) internationalization. Their paper focuses on analyzing the role of cross-border arbitraging activities in the RMB's internationalization measured by cross-border RMB settlements in trade and investment and RMB deposits in the offshore market. They explain how the RMB internationalization was pushed forward from 2010 to 2015H1, and slowed down afterwards. Meanwhile, the role that cross-border arbitraging activities played during this cycle was critically highlighted. Zhang and Zhang provide many interesting observations. I have a number of comments regarding their main arguments and methodologies. Cross-border arbitraging activities must have played a critical role in expanding cross-border RMB settlements in trade and investment and RMB deposits in the offshore market from 2010 to 2015H1. However, Zhang and Zhang have not yet presented a clear assessment of the extent to which cross-border arbitraging activities, relative to other factors such as China's trade and output growth and capital account liberalization, have contributed to the RMB internationalization. They suggest that “cross-border arbitrage could only partly explain the fast development of RMB internationalization, and the rest of the fast development would be driven by the genuine increase in the demand for RMB assets by foreigners and for trade and investment settlement.” A formal test based on an econometric technique could be used to estimate the degree of the contribution that cross-border arbitraging activities made to the expansion of the cross-border RMB settlements and RMB deposits in offshore markets. Related to this point, changes in China's overall exports and imports, in addition to cross-border arbitrage flows, must be a major cause of changes in the RMB's usage in trade settlements. As pointed out by Zhang and Zhang, an expectation of a RMB appreciation (depreciation) and the onshore-offshore interest rate spread influenced the cross-border arbitrage flows in RMB settlements in trade and investment as well as RMB deposits. Zhang and Zhang's Figure 5 also provides evidence that the exchange rate spread between the onshore (CNY) and the offshore (CNH) markets was positively related to the ratio of RMB payments in imports to exports. The widening of the spread induces more cross-border arbitrages: if there is an expectation of a RMB appreciation (depreciation), more RMB payments would take place on the import (export) side. However, it should be noted that the ratio of RMB payments in imports to exports must be also related to the relative change in total exports and imports. Concerning the “bust of RMB internationalization” since 2015H2, Zhang and Zhang focus on analyzing the impact of the new exchange rate regime, and subsequent changes in exchange rates and interest rate arbitrage activities. As they have discussed, China shifted its exchange rate regime on 11 August 2015 towards a more flexible, market-determined system. This new policy had to do with balancing capital outflows and supporting export competitiveness amid a weakening growth environment and an overvalued currency. Increasing exchange rate flexibility also strengthened China's efforts to add the Renminbi to the International Monetary Fund's (IMF's) Special Drawing Rights (SDR) basket. Right after the new policy was implemented, the value of the RMB depreciated significantly in the following weeks, sending shockwaves through global financial markets, and then stabilized largely due to stronger foreign exchange intervention by the People's Bank of China (PBOC). However, since then a prolonged fall in the currency's value and net capital outflows has occurred despite the government's interventions. Zhang and Zhang claim that several factors including an increasing in expectation of a RMB depreciation, a decline of the onshore-offshore interest rate spread, a rise in domestic systemic financial risks, stronger capital account controls, and the PBOC's interventions in the offshore market, weakened cross-border arbitraging activities, causing the “bust of RMB internationalization.” A more explicit investigation of the independent effect of each of these factors on the change in the flows in RMB-denominated trade and capital flows during the “bust” period would be useful to assess the future prospects of the RMB internationalization. Given China's continuous economic growth and greater global influence, the RMB will likely emerge as a new international currency (Lee, 2014). However, this is contingent on achieving high capital account convertibility and developing a more efficient financial system. Zhang and Zhang suggest that to pursue a more sustainable RMB internationalization, the Chinese government should maintain robust economic growth, avoid a financial crisis, liberalize the capital account in a gradual and cautious way, accelerate domestic financial reform, and integrate the RMB internationalization with Asian monetary cooperation. Additionally, it is recommended to set the priorities and adequate sequencing among these objectives. For instance, the government can carry out domestic financial reforms more actively, followed by a gradual capital-account liberalization and RMB internationalization.