Yuan's role presents dilemma for Chinese policymakers

Chinese President Hu Jintao's call at the G20 meeting for enhanced supervision over major reserve-currency issuing economies and an overhaul of the international monetary system triggered off speculation that the Chinese were pushing for the yuan to replace the US dollar as the international reserve currency. In the following piece, two Chinese journalists clarify the Chinese position on this matter and explain how the Chinese view the future role of their national currency in the international financial system.

Liu Jie and Zhang Chongfang

WHILE China's proposal for a super-reserve currency did not make tangible progress at the G20 summit, it wasn't meant to. Instead, it did what it was intended to do: allow China - the largest holder of US debt - to voice unease about US monetary policy.

At the G20 meeting, Chinese President Hu Jintao called for enhanced supervision over major reserve-currency issuing economies and an overhaul of the international monetary system.

Hu's call was not, Chinese analysts told Xinhua, a signal that China wanted its own currency, the yuan, to supplant the US dollar.

What comes next for the yuan is, however, a challenge for China's policymakers as they manage the world's third-largest economy.

They want the currency to have a bigger global role but are wary of sudden or excessive change, so they are taking gradual steps to make it easier to use in trade and investment. But any major global role might be as long as 10 to 30 years away, analysts in China admit.

As it has felt the danger of excessive dependence on the US dollar, China has taken new measures to raise the global stature of the yuan, or Renminbi.

Path to global status

The biggest obstacle to the yuan's use as a reserve currency is that it isn't fully convertible. China is seeking ways to change that situation.

The State Council, or cabinet, said in March that it planned to turn Shanghai into an international financial hub by 2020 - a goal that, in the eyes of many experts, won't be achieved without full convertibility.

The plan 'implies that China will eventually make the yuan fully convertible', Xiao Geng, director of the Brookings-Tsinghua Center for Public Policy, told Nanfang Weekly. 

He said the repercussions of the financial blueprint for Shanghai extended far beyond the city, because the city's role was part of a national strategy.

It usually took 10 to 20 years for developed countries to achieve full currency convertibility in their capital account. For China, the year of full convertibility was likely to be 2016, Chen Yulu, finance professor and vice president of Renmin University of China, told Xinhua. 

He laid out a timetable of global currency status: 10 years to expand the yuan's use in neighbouring countries and regions, another 10 years to bolster its role in Asia and yet another 10 years to become a reserve currency.

China allowed the yuan to become convertible in the current account on 1 December 1996, but it hasn't yet opened its capital account to foreign investors for fear of a massive capital outflow in the case of a crisis, which could damage the country's financial system.

A few programmes have offered foreign investors chances in China's capital market. They include the Qualified Foreign Institutional Investor plan, under which foreign investors can buy yuan-denominated bonds and shares under a quota.

'We should increase the quota and allow foreigners to invest in more types of yuan-denominated assets and financial derivative products, which would bolster their willingness to hold Renminbi,' said Xu Mingqi, researcher with the Shanghai Academy of Social Sciences. 'More policy support is essential,' he said.

China has also been arranging currency swaps with trading partners to bypass the US dollar in trade settlements. Since mid-December, China has signed currency swap contracts worth 650 billion yuan (about $95.6 billion) with six central banks in Hong Kong, the Republic of Korea, Malaysia, Belarus, Indonesia and Argentina.

These swap accords allow other overseas central banks to lend yuan to local importers who want to buy Chinese goods. Since these deals bypass the US dollar, they reduce exposure to exchange-rate volatility and cut transaction costs for both parties.

Chen said these deals 'expand the yuan's use in the region and pave the way for its global acceptance'.

The rules are also good for Chinese exporters, who have long had to bill their foreign customers mainly in US dollars.

Last December, China announced pilot programmes to settle trade deals in yuan between the country's two economic powerhouses, Guangdong Province and the Yangtze River Delta (which includes Shanghai), and the two special administrative regions of Hong Kong and Macao. Trade value among these regions comprised more than half of the country's total last year.

A similar arrangement has been proposed for exporters in Guangxi Zhuang Autonomous Region and Yunnan Province in southwestern China, which will be allowed to use the yuan to settle trade with the Association of South-East Asian Nations members starting this year. Details of that programme haven't yet been disclosed, but experts told Xinhua that it would be yet another step leading to greater use of the yuan offshore.

Smaller arrangements using the yuan  in  trade  actually  date  back  to the 1990s and involve eight close neighbours such as Vietnam, Nepal and Russia. Last year, trade worth 23 billion yuan was settled in yuan between China and these eight border nations.  

But at the equivalent of about $3.4 billion, that was only a minute portion of the trade between China and those countries last year, which was expected to be at least $95.48 billion.

US still has clout

As the largest creditor of the United States, China has made several recent comments on its concern about the safety of its US dollar assets.

For example, Hu has called for 'enhanced supervision' of the macroeconomic policies of various countries, the major reserve currency-issuing nations in particular, with a special focus on their monetary policy.

In March, Zhou Xiaochuan, governor of the People's Bank of China (PBOC), the central bank, called for a super-sovereign currency to end the US dollar's dominance as an international reserve currency. Zhou suggested overhauling the global monetary system by boosting the use of Special Drawing Rights (SDRs, a monetary unit used by the International Monetary Fund) as an alternative to the US dollar.

His proposal sparked heated discussion among world leaders, but so far, there has been more talk than action. Zhou's idea was supported by Russia and Brazil, but it was dismissed by US President Barack Obama, who said he did not believe there was a need for a global currency.

In many experts' view, the US dollar won't lose its global dominance overnight. So it's not entirely surprising nor disappointing that the G20 leaders did not reach a consensus on China's proposal.

The idea of proposing a super-reserve currency itself showed the weakening status of the US dollar. However, since the United States was still  the  world's  most  developed country  and the biggest beneficiary of  the  current  global  monetary  system, it would not cede its currency power lightly, said Hua Sheng, a former policy adviser who was involved in many important economic policies in China such as shareholding reform. 

Guo Tianyong, a professor at the China Central Finance University, said China fleshed out the idea just days before the G20 meeting, and the proposal was meant more to send a message than to translate into something real.

'It sends a clear message to the United States that countries like China have complaints about US monetary policy. The US government should be very cautious

  next  time  when  dealing with money printing plans,' he said.

Zhou's remarks were not intended to achieve a concrete result at the London summit but to shape future discussions, said Xu Bin, a professor with the Shanghai-based China Europe International Business School.

'It is a strategic move with a lot of vision,' he said.

Although the US dollar's pre-eminence would not be hurt in the short run, it was inevitable that the world reserve currency system would expand to a mix of currencies instead of one, said Hua.

The world reserve currency system should not be tied to one country but should develop into a multipolar system based on a group of currencies, said Yin Jianfeng, researcher with the Chinese Academy of Social Sciences, a government think-tank.

He said with such a trade-off, the international monetary system could be sustainable in the long term.   

'The Renminbi should take a key part in the international reserve currency basket, although that will take time,' he said.

'I think China should play a cooperative role with Japan, South Korea and other Asian countries to introduce a regional currency, while the world is trying to replace the old reserve currency system,' Jeffrey Sachs, special adviser to UN Secretary-General Ban Ki-moon, told the China Daily newspaper on 3 April.

He said the US dollar, British pound, euro and a regional currency in Asia could form a basket of global reserve currencies.

Market forces decide

Although China is moving forward on the road to having an international currency, it will take its time and achieve its goals in a balanced way, analysts said.

'It is possible that the global financial crisis will facilitate the process of making the yuan internationally  accepted,  but  there  is  no  need to push for that,' PBOC vice governor Yi Gang told Xinhua in early March.

A currency's international acceptance would be ultimately decided by market forces, not government fiat, said Jiao Jinpu, a PBOC economist. He said China should continue to increase the yuan's use in regional trade settlement and pricing as a foundation for expansion of its role.

Yin said there were still many areas for improvement in China before the yuan would have a global reach. One really pressing area, he said, was to make the economy more domestically driven. Declining exports could produce a deficit in the current account.  

China must rebalance

The United States hadn't forced China to accumulate such a huge US dollar stockpile, so it was up to China to reduce its reliance on exports as a source of growth and keep foreign reserves at a balanced level, said Yin.

In addition, China lacked the kind of deep financial markets that could supply varied derivative products, which made the yuan less appealing, Yin said.

He also noted that economic and military muscle were, as always, the fundamental factors behind having a strong reserve currency.

Zuo Xiaolei, chief economist with Galaxy Securities, said China did not actually have many choices at present, since few investments were likely to show easy profits given the current global economic downturn.

'Political and economic ties bind China and the United States together; they are in the same boat,' she said. - Xinhua                      

*Third World Resurgence No. 224, April 2009, pp 20-22