China’s currency ambitions

The evolving world economic order is in the process of accommodating the rising economic clout of China. All leading trends and forecasts indicate that China’s ascend to the top position edging out the US, will be much quicker than previously expected.

          Developments in the post- crisis period gives ample proof that China is navigating arrangements and agreements on a strong foot to achieve the various externalities related with its rise in the global economy. A major objective of Beijing on this front is to make renminbi a global reserve currency.  Over the last few years, Chinese political leadership and policy makers were openly criticizing the dollar hegemony. Former President Hu Jintao has described the present international monetary system characterized by Dollar supremacy as a ‘product of the past.’

          Frequently, China is demanding the restructuring of the SDR’s (Special Drawing Rights, which is the reserve currency of the IMF) currency basket base. Broad basing of the SDR currency basket is an important part of China’s IMF reform package. Here, Beijing’s intention is to include renminbi as a reserve currency in the SDR’s reserve basket.

Exorbitant Privilege

          Recently, a number of countries including reserve currency aspirants as well as sovereign investors in US government securities are raising concerns about the Dollar’s international status. The dollar’s supremacy and the plausible gains accrued to it did not remain historically unnoticed. Former French Finance Minister Valery Giscard d’Estaing has observed that the US continues to enjoy an ‘exorbitant privilege’ because of the reserve currency status of the Dollar.

          Giscard’s view that the US enjoys privilege as the supplier of the world’s most sought reserve currency has supported by events in the recent years. The US is the largest debtor of the world and it has the largest trade deficit in absolute terms. But still in the last five year or so, it is coming out of this economic catastrophe without being hurt, mainly because of the reserve currency position of the Dollar. Central banks and government affiliated institutions are investing their dollar earnings in US treasury bills and thus the American government was able to finance its historically high deficits out of foreign borrowing. Another perplexing angle of the privilege is that over the last few years, the world is witnessing a strange phenomenon of weakening of the US economy and strengthening of Dollar’s reserve currency status.

          Indeed, the US is enjoying an exorbitant privilege despite losing of its economic sheen. But brilliant performers like China are understandably annoyed of this. At the same time, major reserve holders having made big investment in Dollar denominated US treasury bills doubts about the Dollar’s supremacy unsupported by the performance of its economy. Migration to non-dollar denominated sovereign assets is a matter of wise decision for them to make the value of foreign exchange reserve safe. Here lies the opportunity of China to develop the renminbi as an international currency.

          So China need not prepare a coup to bring the dollar down. Interestingly, Beijing is not sitting passive. It is co-working with like-minded people who have doubts about the continuation of the Dollar hegemony. In the last few years, China is using various international forums and bilateral agreements to augment the internationalization of renminbi.

          A search into economic history reveals that internationalization of a currency and acquisition of reserve currency status is a long term process. For example, the US became the largest economy in 1870, but its currency got international status only by 1925. At a closer look, it seems that the Dollar travelled many distance from 1914, when the currency was nowhere near to a hard currency; to an international currency in 1925. The process was much quicker because of the weakening of the British economy at the impact of the First World War. The fall of sterling and the rise of dollar have coincided with the weakening of the British economy and the ascend of the US economy. But it has been quickened by the destructive effect of the war on the British economy.

          A similar situation is not there in ‘the new battle in the new century’ where the renminbi is pitted against the dollar. Here, China has to make various promotional measures for its currency. First is internationalization; which means denominating and settling cross border trade and financial transactions in renminbi. Second is capital account convertibility measures to facilitate inflow and outflow of capital. Third, other central banks should hold renminbi as a protection against balance of payment crisis.   An excavation on recent issues reveals that China is tailoring and implementing programmes on all these fronts to quicken the reserve currency status of renminbi.

Internationalization of Renminbi

Despite rising trade share, the role of renminbi as a reserve currency remains disproportionately small. At present, trade settlement in renminbi is a meager 0.2% of the total world trade. Researchers on the topic project that renminbi should go a long way to get the status of a reserve currency.

Raising the status of renminbi to a reserve currency is one of the strategic ambitions of Beijing. Often they have expressed this intention in quite vocal manner itself. But the notable part of their currency policy is that over the last five years China has developed a clear plan and implementing it with clinical precision. Chinese efforts for the internationalization of renminbi are done through different modes. Firstly, Beijing is signing bilateral agreements for using domestic currency for trade settlement. The purpose here is to compel trade partners to use renminbi rather than dollar. Local currency trade settlement agreements were reached between China and its major trading partners including Russia and Japan. Such agreements will lead to less dependence on Dollar for conducting trade at the same time promoting the use of renminbi.

The internationalization of renminbi using the trade channel is a rewarding strategy as China is emerging as the largest trading country. If Beijing is able to settle bilateral trade transactions with non-reserve currency countries in renminbi, it means that nearly half of Chinese trade will be settled in renminbi in the immediate future. Since the trade share of China is expanding rapidly, local currency trade settlement would be the most rewarding way to internationalize the currency.

The second channel for internationalization of renminbi is to open up the Chinese financial market. Capital account convertibility with opening up of the credit, equity and bond market is a necessary prerequisite to enhance the demand for renminbi. For this, China has recently allowed its government securities market to other central banks and government owned institutions.  Japan has already purchased US $10.3 billion worth of Chinese government bonds. Other countries including Malaysia, Austria, Indonesia etc have also bought Chinese bonds.

For foreign central banks, opening of Chinese bonds market is an additional safe investment opportunity. The advantage is that they can now spread their investment to a wider range of assets instead of concentrating it on Dollar denominated US treasury bills. If China is liberalizing its bond market at a quicker pace, major reserve holding central banks in the immediate future may reallocate their holding in favour Chinese government securities away from the US securities.

On the third channel, Beijing is campaigning for the governance reform at the IMF, expecting that it may facilitate status quo of renminbi as a reserve currency. In major economic forums Beijing’s demand is to make the international monetary system more ‘broad based’. The implied demand here is to make renminbi as a reserve currency of the SDR’s currency basket.

China’s currency ambitions and the BRICS

From its first summit at Yekaterinburg to the last summit at Durban, the BRICS is very vocal in raising objections against the shortcomings of the west dominated international financial architecture.

The BRICS has concern over the governance as well as the performance of the Breton woods institutions. Similarly, it holds the view that the west is busy in designing the bailout type transient mechanisms and adjustments to the existing institutions to heal their financial disorders. These disorders were largely the outcomes of their weak regulations of financial systems and innovations which had little social value. So, a client based governance of international financial institutions is needed to give priority to the development issues of the south.

The BRICS’s main purpose is to claim a due share for its members in the international monetary system. Here, it is natural that as China is the most powerful country in the emerging world, the organization’s demand for bigger role effectively becomes a bigger role for China. So far this has happened in the working of the BRICS if the decisions reached at various meetings are evaluated. The Chinese efforts to enhance the internationalization of renminbi and the demand for a fair role in the reserve currency system of the IMF were important part of the declarations at various BRICS summits.

Beijing has used the BRICS platform to promote the renminbi through different ways. Firstly, within BRICS, agreements for settling trade in domestic currencies were reached with Russia and a currency swap agreement was signed with Brazil. Secondly, to encourage the use of its currency, renminbi denominated lending within the organization was launched. Thirdly, China was successful in inducting the demand for reforming the international monetary system by making a broad based currency reserve system at various BRICS summit declarations.

In the Yekaterinburg summit, the main resolution ratified demanded for a more diversified international monetary system. Even though it is not elaborated, what is implied here is the diversification of the SDR basket of reserve currencies by including the national currencies of the BRICS members. Certainly, it is an indirect proclamation of the renminbi’s candidature.

At Brasilia, the summit declaration aired a more radical Chinese voice by urging the members to make local currency trade settlements.

The Sanya summit which China hosted in 2011 witnessed a complete takeover of Chinese currency campaign in the summit declaration, though other issues also got their usual place. For the first time, the BRICS declaration demanded a more broad based currency reserve system. More specifically the declaration said that “We welcome the current discussion about the role of the SDR in the existing international monetary system including the composition of SDR’s basket of currencies.” Here, the Chinese demand for the inclusion of renminbi in the SDR’s basket of currencies has got an important place.

The Sanya declaration has implicitly contained intra-BRICS arrangements for the internationalization of renminbi. The meeting decided ‘to gradually increase mutual credit lines denominated in national currencies and to settle transactions in national currencies in order to promote mutual trade and investment.’ Renminbi denominated lending was an additional step to promote Beijing’s currency aspirations and China Development Bank played an active role in Intra BRICS lending under BRICS Inter-bank Cooperation Mechanism.

The New Delhi summit has shown the depth of divergence of interests within the BRICS. The summit declaration was silent on currency based reform of the international monetary system. It only urged for a representative international financial architecture by accommodating the voice of the developing world. Similarly, there was no mention about local currency trade settlement which found a place in Brasilia and Sanya. The only specification which seemingly supported the renminbi promotion was the Master Agreement on Extending Credit Facility in Local Currency. The Master Agreement enables China to give renminbi denominated lending and thus to help the internationalization of its currency.

At Durban, the Chinese renminbi ambitions made a strong come back. The summit declared that “We support the reform and improvement of the international monetary system, with a broad-based international reserve currency system… We welcome the discussion about the role of SDR in the existing international monetary system including the composition of SDR’s basket of currencies.” Thus, the Durban summit completely reflected the Chinese currency ambitions. An important development at Durban was that at the meeting, China and Brazil have reached a currency swap deal.

So far, Beijing’s self interest in BRICS figures mainly in the form of its currency ambitions. But the ability of BRICS to collectively force a new world economic order is doubtful. Looking from inside, the organisation is visibly divided and tensed because of the overweight of China. The Durban summit was able to create a currency reserve fund. But it has only an ornamental value and the decision doesn’t test the unity of the members. On the other hand, setting up of a development bank involves conflict of interests. Here, the BRICS was not able to reach a consensus at Durban. Thus, strong fault lines are appearing within BRICS which indeed may determine the future of the organization.