Though much has been written about when China’s currency, the renminbi, will assume an international role, less attention has been paid to where. One view is that the renminbi will eventually challenge the dollar as the leading global currency. The alternative is that the renminbi’s future is as the leading regional currency in Asia. This column evaluates the two views on the renminbi’s prospective role as an international unit of account, means of payment and store of value for private and official transactions.
The case for a global currency
The case for a global currency runs as follows. China’s foreign trade and financial transactions are widely distributed across regions. Figure 1 shows the geographical distribution of exports. Only a quarter go to other Asian countries, excluding Hong Kong, Macao and Taiwan, while an additional 24% go to Europe, and 23% to North America.
Figure 1. Regional composition of China’s exports, 2013
Source: UN Comtrade Database.
*Note: Taiwan is included in Other Asia, NES in UN Comtrade data.
At first glance, the direction of China’s foreign direct investment, in Figure 2, is more concentrated, with the majority destined for Hong Kong, Macao and Taiwan. But these offshore centres serve mainly as intermediaries for Chinese FDI destined for other countries. Excluding offshore centres, Chinese FDI is widely distributed, with equal slices directed at Asia, Europe and Latin America. This reflects investments by Chinese enterprises in commodity- and energy-related sectors as well as manufacturing.
With the growth of these trade and financial links comes an incentive to stabilise currencies against the renminbi, which encourages central banks to hold renminbi-denominated foreign exchange reserves and establish contingent renminbi liquidity lines with the People’s Bank of China (PBOC).
Figure 2. Regional composition of China’s overseas direct investment, 2013
Source: CEIC Database.
Are these tendencies limited mainly to Asia or observed more widely? To address this issue, Subramanian and Kessler (2013) estimated regressions, where the value of the local currency against a numeraire, the Swiss franc, is taken as a function of the renminbi/franc, dollar/franc, yen/franc and euro/franc rates. We update their results for a sample of 41 countries for the period July 2012-July 2015 with results summarised in Table 1.
In addition to having the strongest effect in a number of Asian countries, the renminbi also has a significant effect in several European countries, and a statistically significant effect in a number of South American and other European countries. The renminbi tends to be important for Russia and Ukraine, as well as for countries elsewhere such as India, Israel, Macedonia and Peru. As in Subramanian and Kessler, the weight on the renminbi is plausibly a function of commercial and financial links between a given country and China. And, as documented above, those commercial and financial links are as much global as regional.
The question can be addressed from an institutional perspective as well. Beijing has used the China Development Bank and its Export-Import Bank to promote renminbi-denominated lending and settlement. Countries to which these institutions lend receive funds in renminbi, which they then use to finance imports of merchandise from China and to purchase the services of Chinese construction companies. A non-negligible share of lending by these state banks is to countries and companies outside the region (to the government of Venezuela in 2010, for example, and to small and medium-sized enterprises in a variety of African countries).
Other institutional bases for wider international use of the renminbi include swap lines with the PBOC, the designation of a Chinese financial institution as official clearing bank for settling renminbi-denominated transactions, and a quota for investing in China’s local-currency equity market (an RQFII quota). In practice, these arrangements extend beyond Asia. Foreign financial centres with designated renminbi clearing banks now include many cities outside of Asia, such as Frankfurt, London, Paris, Sydney and Toronto. Virtually all countries with official clearing banks have RQFII quotas. So these too extend far beyond Asia.
Central banks in 30 countries at the time of writing have swap lines with the PBOC. Thirteen of these bilateral swap arrangements are with Asian central banks, while 11 are with European central banks and others are with central banks in additional parts of the world. China’s third largest swap line is with the ECB, reflecting the fact that China is the EU’s second largest export market.
Finally, China has supplemented these bilateral renminbi swaps with a BRICS Contingent Reserve Arrangement (CRA). Under the CRA, participating central banks will be able to draw up to $100 billion of international reserves from one another, subject to conditions. China has made the largest initial commitment, of $41 billion, to the CRA. Revealingly, China’s partners in this arrangement include countries outside Asia (Brazil, South Africa) as well as countries within it (India and Russia).
The renminbi as a regional currency
The case for the renminbi as a regional currency starts from the observation that China and other Asian countries are natural trading partners. Underlying this pattern is the fact that trade costs still matter for cross-border commercial transactions, and geography is still relevant to trade costs. Transport costs are a significant portion of total trade costs. Abe and Wilson (2009) confirm that transport costs increase with distance. It follows that Asian countries, and in particular those that border the South China Sea, are natural trade partners.
Another way of gauging whether economies are natural trade partners is on the basis of relative resource endowments. There is no question that resource endowments vary widely within Asia. For example, China is poorly endowed with natural resources compared to some of its Asian neighbours. Further, its labour force peaked in 2010, and as a result, unskilled labour is becoming increasingly scarce relative to say, Indonesia, India and Bangladesh.
Intra-industry trade is another important dimension. China has long been involved in regional supply chains, most prominently in consumer electronics, importing semiconductors from Japan, South Korea and Taiwan, and combining them with other components before exporting a final product. On the demand side, it is likely that Asia will become an increasingly important destination for these Chinese products, as these countries increase income and wealth per capita and develop their middle classes.
Similarly, distance also continues to play a role in international financial transactions. Portes and Rey (2000) and Portes et al. (2001) study cross-border financial transactions in US equities and bonds and show that distance still matters after controlling for other determinants of the volume of these transactions. Analysing foreign direct investment flows, Brainard (1997), Gao (2009) and Paniagua (2011) show that such flows vary inversely and significantly with distance. The association between cross-border financial flows and proximity presumably reflects costs of information acquisition and corporate control, which historically have tended to increase with distance.
A variety of Asia-specific institutional and policy initiatives further support the argument for the renminbi as a regional currency. The Asia Infrastructure Investment Bank is designed to promote infrastructure development in Asia. China’s Silk Road Initiative is designed to promote trade and economic integration in Central Asia. China signed a free trade agreement (FTA) with ASEAN in 2002, which came into operation in 2010. An FTA agreement with South Korea was also recently signed. China was a founding member in the Asian Bond Market Initiative (AMBI) established by the ASEAN+3 countries following the 1997-1998 Asian financial crisis. The ABMI is intended to promote the integration of regional debt security markets, and markets in local currency debt securities in particular, by sharing information on best practices and applying pressure for standardisation. Insofar as standardisation includes standardisation on a specific local currency, the currency in question will plausibly be that of the largest issuer, namely China.
Further, China is the largest contributor, along with Japan, to the Chiang Mai Initiative Multilateralisation (CMIM) through which the ASEAN+3 countries extend swap lines and credits to one another. Like other swaps, local-currency lines of credit through the CMIM will encourage regulators to permit banks and firms under their jurisdiction to incur exposures in foreign currencies, since local central banks gain the power to engage in at least limited last-resort lending in those currencies. The renminbi is the currency that appears most frequently in this connection (in three out of four cases). The CMIM thus provides a natural institutional platform for the renminbi in the ASEAN+3 region.
Use of the renminbi by commercial banks and enterprises will in turn encourage Asian central banks to hold more renminbi as reserves, enabling them to stabilise the renminbi-local currency exchange rate and act as lender of last resort in renminbi to the banks and firms in question. In fact, the majority of ASEAN+3 central banks already have indicated that they have added the renminbi to their reserve portfolios. Early adopters include Malaysia, Cambodia, Philippines, Singapore and Thailand.
Finally, insofar as political power and leverage matter for international currency use, it is worth noting that China is best able to project such power and influence in the South China Sea and elsewhere in Asia. Consistent with this, Asian countries’ willingness to participate in institutional arrangements with China reflects the fact that the same countries benefit from these relationships with China. All these are reasons for believing that the renminbi’s future is as a leading regional, not global, currency.
Forecasting is difficult, especially when it involves the future. Any forecast about whether the renminbi’s future is as a global or a regional currency should therefore be taken with a grain of salt. So instead of forecasting, we have done our best in this column to make the cases for both scenarios.
As for which scenario is more likely, one can only echo Zhoa Enlai (speaking not of the French Revolution but of the French student demonstrations of 1968, in actual fact), that it is early to tell. This column at least identifies some of the factors on which the answer will hinge.
Table 1. Dominant reference currency by region (2012-2015).