Yuan could rise as ‘supercurrency’

The drumbeats of a ‘currency war’ are resonating around the world, with countries competing with one another to devalue their currencies.

But economists and market watchers reckon that out of the dust kicked up by the slugfest, the Chinese currency — the yuan (or renminbi) — will inevitably emerge as the next preferred currency of global trade.

 “Confidence in international currencies could break down to such an extent that it could lead to sharp changes in the near future,” says Joseph Yam, who retired last year as chief executive of the Hong Kong Monetary Authority, the world’s highest paid central banker.

In such a scenario, and in the absence of any other credible alternative to the US dollar as the reserve currency of choice, “the market may in the end turn to a sovereign currency currency — and that currency, I think, could be the renminbi,” he adds.

Yam concedes that there are certain pre-requisites that must typically be met before that eventuality happens: for instance, the yuan should become fully convertible, the domestic debt market in China should acquire depth, and a robust financial infrastructure should be put in place. But, he points out, “these are precisely the strengths of Hong Kong”, where the most ambitious experiment in internationalisation of the yuan is progressively underway.
The Chinese economy “is too big to be linked to any one currency like the US dollar,” say Guonan Ma, senior economist at the Bank for International Settlements. And although Chinese policymakers would face certain downside risks associated with taking the yuan international, “the benefits for China far outweigh the costs,” he reckons.

Ma, in fact, believes that it isn’t entirely necessary for the yuan to become fully convertible for it to be gradually internationalised. “At the time of the Second World War, the US dollar emerged as the reserve currency even though there were capital controls in place in the US,” he points out. Likewise, in his estimation, a fully convertible currency may not make any progress towards internationalisation. “The two are interactive, but distinct processes.”

But can China, which runs a balance-of-payment surplus by keeping its currency artificially pegged, take the yuan global without changing its export focus? “This raises a fundamental question, which economists refer to as the Original Sin problem — of the sort that emerging market economies in Asia and Latin America faced,” says Li-Gang Liu, head of China Economic Research at ANZ Banking Group HK.

It could be done, reasons Liu, if China built up good institutions, established rule of law, property rights, good corporate governance and stringent prudential regulations. “For China to overcome this problem it must have a sophisticated financial system, with long-term bond markets and a liberal capital account,” he reasons.

Yam, however, disagrees. “I don’t think it is necessary for a country that wants to internationalise its currency to run a trade deficit,” he argues. 

So how can China, while still running a trade surplus, get out enough renminbi into the world so others can use it to pay for its exports? “It can lend, of course,” says Yam. And that’s precisely what China’s central bank, the People’s Bank of China, has been trying to do by establishing currency swap agreements with central banks around the world. 

 “If you use the renminbi as the medium of transaction, instead of having to acquire US dollar assets, the PBoC will have assets in the form of renminbi loans, which is an improvement,” he asserts.

What downside risks will Chinese policymakers face as the yuan becomes international? “When you operate a free and open financial system, it comes with risks, such as vulnerability to volatile international fund flows,” points out Yam.

Ma too reckons that there could be a “number of potential complications” as the yuan becomes more international: for instance, policymakers may lose some degree of freedom because the domestic policymaking authority “will have to take into consideration the international repercussions” of their policy measures.

Liu reckons that China will adopt an ‘incrementalist’ attitude towards internationalising the renminbi. “The process of domestic financial liberalisation could take ten years so as to avert any financial crises,” he reckons.

But economists agree that the rise of the renminbi is inevitable - and desperately needed. “The international monetary system today is pretty wobbly,” says Yam. “From the point of view of stabilising the international monetary system, there is a need for a multipolar type o of system.” And for China too, he adds, it makes sense to promote the gradual use of the renminbi in trade settlement.