by Sun Lijian and Peng Shutao
While China possesses the world’s largest foreign exchange reserve, it cannot also evade involvement in the crises that beset the world. It is time to consider how can RMB become an international currency and, at the same time, weather external financial risks, for a stable international monetary system and its financial markets are in great need of China’s contribution.
The present global economic fluctuation offers RMB an excellent opportunity to go global. The subprime crisis has seriously damaged the USD’s status as the international reserve currency. Although USD rebounded in August with the Fed interest cut, USD will not strengthen significantly soon. In fact, a weak USD is better for the improvement of the US economy. The stronger Euro has affected the exports of Europe, while the slowing Euro-area economy means the Euro won’t be able to fulfill the room left by the weakened USD. In this situation, the internationalization of RMB is widely expected in the international financial market. Although hot money inflow is likely to increase in future, it is also likely to become long term investment, since investors, whether domestic or overseas, are all eager to find a new harbor for their funds to avoid risks from the fluctuating global financial markets and, at the same time, to share the outcome of China’s economic development.
There are various paths RMB can take toward globalization. For instance, the Chinese government may consider issuing RMB government bonds in the international market when RMB bonds issued in Hong Kong by Mainland financial institutions are welcomed by the market. With USD credit being overdrawn, central banks will certainly reduce their holdings of USD reserve, so international bonds issued by the Chinese government will become an instrument for RMB reserve. Once RMB becomes recognized by the international market, Chinese enterprises will be able to choose RMB quotation, which will partly relieve the affect of RMB appreciation on China’s export industry. The People’s Bank of China, China’s central bank, has already formed an exchange rate department, providing policy guarantee to RMB internationalization and more flexible exchange rate. RMB internationalization can also solve the conflict between China’s swelling foreign exchange reserve and lack of diversification in its structure, and therefore greatly relieve the inflation pressure led by domestic liquidity surplus.
(Sun Lijian is a professor of economics at Fudan University, and Pen Shutao is his Ph.D candidate. )