Comments by Anwar Nasution, on The Economics of RMB Internationalization

Abstract

Anwar Nasution: It is my pleasure to comment on this excellent paper on the important topic of analyzing the People's Republic of China's (PRC) reforms over the past decade to move toward internationalizing the Renminbi (RMB). The RMB is beginning to be used as an international medium of exchange in dominating and setting cross-border trade and financial transactions. The paper summarizes the benefits and costs of RMB internationalization from a theoretical point of view. There are also econometric studies on the impacts of RMB internationalization on financial development in the PRC and the estimate of seigniorage revenue of RMB, but there is no estimate on the inflationary tax enjoyed by the PRC from foreign holdings of its currency. In addition, internationalization of the RMB allows the PRC to borrow from the international community with liabilities denominated in that currency without exchange rate risk. Unfortunately, there are no brief summaries of PRC government policies on how to make the RMB become an international unit of account, medium of exchange, and store of value. Also there is no information provided in the paper on the size of capital markets in the PRC: the structural financial system, the size of public sector debt and security market, and their liquidity.The use of the RMB as international money indicates the readiness of the PRC to take a greater role in managing the global economy. Because the PRC has become the second largest economy, after the United States with a larger share of global trade, the RMB has been used by its neighbors in ASEAN and east and central Asia as a medium of exchange and a unit of account for pricing and settlements of bilateral trade with the PRC. The use of the RMB in regional trade is rapidly increasing as the PRC has allowed a number of enterprises in selected cities to settle trade in that currency. Trade between the PRC and ASEAN rapidly increased after the establishment of the China–ASEAN Free Trade Area (CAFTA), effective January 2010. Stronger economic links in east and southeast Asia has been reinforced by the international production networks of the multinational companies that encourage intra-industry trade in this region.On a limited basis, the PRC allows some companies to issue RMB-denominated bonds, popularly known as dim sum bonds and Panda bonds, in Hong Kong. Personal use of the RMB is encouraged by allowing financial institutions in Hong Kong to open RMB-denominated accounts and its use for cross-border settlement including sending remittances to mainland China. Starting from a small amount, the RMB has been used as store value in a number of emerging economies such as Belarus, Cambodia, Malaysia, Nigeria, the Philippines, Korea, Chile, and Russia, as they hold RMB in their international reserves as an insurance against balance of payments pressure. This indicates trust from the international community of the stability of the RMB as a safe asset and confidence in its future role in the international monetary system.Sitting on huge foreign exchange reserves, the PRC and Japan have provided liquidity supports to central banks of many emerging economies during times of crisis. Under the Chiang Mai Agreement (CMI) of 2000, the ASEAN+3 countries1 have bilateral currency swap agreements. The multilateralization of the CMI in 2008 was a great leap forward in traditionally less politically cohesive ASEAN+3 countries as they transferred some of their national powers to a regional supranational authority, namely, the Chiang Mai Initiative Multilateralization (CMIM). The PRC made a significant contribution to the pooled funds in the CMIM. The currency swap facility promotes the use of the RMB in international trade and financial transactions. The paper can be improved by presenting information on (i) how much of China's total trade in goods and services has been settled in RMB; (ii) the size of dim sum and Panda bonds and the size of RMB-denominated accounts; (iii) the size of international reserves of foreign central banks denominated in the RMB; and (iv) the size of bilateral swap lines with foreign central banks.I agree with the authors that making the RMB a reserve currency or an international store of value is a long-term goal. This is simply because the Chinese economic system is in transition from a highly regulated to a market-driven economy. A number of policies should be taken to make it happen. For example, the legal system needs to be reformed to protect individual property rights and uphold business contracts, which are the basic elements of the market economic system. Regulations need to be introduced to allow transparency, governance, and prudence of the market.Specifically, the government should allow the RMB to be traded 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 accounts. The goal of government intervention should be limited to prevent volatility in the thin foreign exchange and financial markets. Second, the government needs to adopt a flexible exchange rate system and allow market forces to determine the external value of the RMB. This requires the end of the long practice of manipulating the exchange rate for mercantilist purposes and the use of it to promote export and restrict import and to reallocate resources from the non-traded sector to a traded one within the domestic economy. Moving away from mercantilist currency manipulation should, fundamentally, eliminate China's contribution to the global saving glut. The exchange rate system, however, does not necessarily mean that the central bank cannot intervene in the relatively thin foreign exchange market to prevent exchange rate volatility, which severely affects balance sheets of financial institutions and the corporate sector. In particular, the central bank should be aware of speculative attacks.China has made some progress in both the capital market and the exchange rate policy by allowing more market forces to play. The government has gradually allowed foreigners to penetrate Chinese financial markets. To develop the stock market and boost stock prices, the government should relax margin requirements, making it easier to buy stock with borrowed money from the banks. Another objective of this policy has been to allow state-owned enterprises (SOEs) to repay their debt by selling stock. These policies have created bubbles since 2014. To stabilize the capital market, authorities immediately implemented a reversed stop to support the market, which bans short selling and pushes large investors to buy.The movements of the market forces have significantly undervalued the RMB as compared to over-valuation several years ago. To restore the equilibrium rate, Chinese authorities recently devalued the RMB by 4.4 percent—this government intervention has ignited capital outflow from the country, however.Third, the PRC should develop deep and liquid deregulated financial markets with a wide range and large volume of financial assets and high level of turnover. Unfortunately, there is no information in the paper on the structure of the PRC's financial market. At present, in terms of asset and branch networks, the financial system of the PRC is still denominated by state-owned banks with limited competition. The system is still relatively closed and repressed as the government sets both the interest rates of banks’ deposits and loans as well as the allocation of bank credit by economic sector and class of customers. To boost economic growth during the 2008–09 global financial crisis, the government had promoted spending in infrastructure and real estate as well as funneling cheap program loans to SOEs. These caused over-investment in infrastructure and real estate as well as increasing the debt load of SOEs. Nevertheless, the central government has the resources to avoid financial instability, which alleviates worry.China has also recently made progress toward allowing a market mechanism to set the interest rate for big bank deposits. Certificates of deposit require a minimum amount of RMB 30,000 for individuals and RMB 10 million for companies. The high threshold is designed to avoid an abrupt rise in banks’ funding costs as customers switch from regulated to unregulated deposits. It is expected that the authorities will gradually lower the thresholds. This program is an important step for full liberalization of the traditionally controlled deposit rates to allow market forces and to shift China's growth model away from state-directed investment.With a limited equity market in a socialist PRC, the financial instrument is dominated by the government debt market either issued by the central government or by provincial and local governments of state-owned banks and enterprises. There is no incentive for SOEs to issue equities and bonds because of the availability of loans from state-owned banks with low interest rates and low risks. Are there string institutional investors, such as the insurance industry and pension funds, to absorb government debts? The trust of the international community on government debt of the PRC is dependent on its macroeconomic policies in maintaining low inflation sustainable public debt and stability of the RMB. Under the fixed exchange rate system, the sole objective of the monetary policy is to maintain stability of the exchange rate. Sustainability of the public debt is affected by fiscal and debt rules of various levels of the government.