By Jacob Kurien and Bernard Yudkin Geoxavier

“A currency of a country which is important in world markets will be a better candidate for an international money than that of a smaller country.” Krugman (1984)[1]

Although 2020 will go down as the year of a global pandemic and political and economic disruption, China has continued its journey to re-establish itself as a prosperous superpower. As noted by Secretary General of NATO Jens Stoltenberg, “The rise of China is fundamentally shifting the global balance of power and heating up the race for economic and technological supremacy.” [2] Thus far, China’s ascension has been delivered through its military modernization and manufacturing might. But China’s most critical source of power moving forward will be the internationalization of its currency, the renminbi (RMB). In the 13th Five-Year Plan (2016-2020), a macro-political agenda set forth by the Politburo Standing Committee and adopted by the People’s National Congress, central planning leadership reiterated that the Chinese goal is to “steadily promote RMB internationalization and see RMB capital go global.”[3] To be successful, China should consider opening its capital market and allow capital flows to cross-border financial transactions; allow interest rates to be market determined; let the currency be fully convertible; and ease capital controls and regulations, all the while forging deeper trust so that the renminbi can become a globally accepted currency. 

Our previous paper[4] examined the currency’s status and laid out a roadmap for more widespread adoption of the RMB, given the challenges of the 2010’s under both the Obama administration and the start of Xi Jinping’s first term as Chairman. Since then, China started on one of the paths we prescribed: pushing the RMB as the currency of choice for partners of the Belt and Road Initiative (BRI). Through the BRI, created by President Xi Jinping in 2013, China has initiated a vast array of trade and infrastructure projects in over seventy countries across the globe to pioneer a China-centric international economic system.[5] Since its inception, China’s trade volume with participant countries exceeded US$6 trillion, displaying an annual growth rate outpacing that of China’s total foreign trade.[6] While this program promises mutually beneficial economic development, it can also be viewed as a projection of soft power , offering alternatives to American, Russian, or European-led initiatives.[7] China emerged more confident on the world stage and less fearful of conflict, despite an increasingly tense relationship with the United States.

Today, it is beyond dispute that the RMB stands as the greatest potential rival to the U.S. dollar (USD).[8] China’s economic size, prospects for future growth, integration into the global economy, and efforts to internationalize its currency point toward an expanded role for the RMB in international macroeconomics and trade. China’s successes in the realm of financial technology, the rapid adoption of mobile online transactions such as Alipay and WeChat Pay, and its digital currency pilot project are each bridging the gap between today’s USD dominance and a potential RMB-led future.

However, although growth in international trade made China the world’s second largest economy and largest exporter,[9] use of the RMB has not grown as extensively as Chinese production. There is a disconnect between the high percentage of global goods transitioning through China and the primary use of the USD as the monetary unit for accounting throughout the global supply chain. Currently, the RMB accounts for only 1.88 percent of global payments.[10] As we will see, China’s own moves – domestically, regionally, and globally – possess the potential to undercut any progress on broader adoption of the RMB. 

RMB Internationalization: An Economic Perspective

Both political and economic factors impact the rate of RMB internationalization. The domestic economic determinants are mainly capital account openness, financial market development, and interest rate/exchange rate liberalization, each of which is considered a necessary condition for internationalization. The performance of BRI members amidst the global pandemic, coupled with a new wave of anti-Chinese rhetoric in the United States and abroad, also play important roles in dictating the pace of internationalization. The economic rationale for RMB internationalization is that it will help reduce the transaction costs of cross-border trade, reduce exchange rate fluctuation risks, and increase the number of financial transactions in renminbi, particularly with China’s major trading partners.

The Chinese government has begun an extensive process to internationalize its currency. Starting in recent years but increasing this last summer, the People’s Bank of China (PBOC), on the recommendation of the State Administration for Foreign Exchange (SAFE), expanded the use of the RMB to promote global trade settlement. The process outlines the following three stages:

1. Establish the RMB as a global trade currency used internationally to pay for goods and services,

2. Establish the RMB as a global investment currency used internationally to buy assets,

3. Establish the RMB as a global reserve currency, indicating that the RMB is seen as a reliable store of value for central banks and establishing China as a trusted global economic leader.[11],[12]

With these goals in mind, over the last ten years, several institutions enacted a series of policy driven changes. Such changes include:  

- PBOC set up the Cross-Border Interbank Payment System (CIPS) as an alternative to the Western-backed SWIFT,

- CEINEX (China Europe International Exchange) launched as the first platform for RMB denominated trading outside mainland China,

- IMF included the renminbi in the basket of currencies that constitute the IMF’s Special Drawing Rights (SDR),

- China signed bilateral Currency Swap Arrangements (CSAs) with thirty-six foreign central banks,

- PBOC invited foreign central banks, sovereign wealth funds, and international financial institutions to enter China’s interbank foreign exchange markets,

- China deregulated commercial bank deposit interest rates,

- China highlighted and prioritized free trade zones in Guangdong, Tianjin, and Fujian provinces.

China has widely promoted RMB internationalization through bilateral infrastructural investments and trade missions. Along with the development of China’s international investment projects such as BRI and the Asia Infrastructure Investment Bank (AIIB), Beijing is moving towards the creation of a nationalized digital currency. This new digital currency could reshape the international financial system as an “e-RMB.” It could be widely used in global settlements and reduce China’s dependence on other convertible national currencies.

Considering the many policy initiatives taken by PBOC over the years, the RMB’s inclusion as an IMF Special Drawing Rights currency, and the explosive opportunity in digital currency use, the RMB may prove to be re-inventing global finance. In part due to these policy changes, the recently signed Regional Comprehensive Economic Partnership (RCEP), a newly formed trading bloc incorporating China and fourteen other nations, arrived at a time when China is well positioned to capitalize on its scope and timing. Without India or the United States, RCEP is implicitly a Chinese-centric deal, which will only benefit China’s promotion of the RMB in international settlement within this bloc. Thus, RCEP offers the opportunity for China to peacefully take the lead in multilateral trade policy, free of conflict or tension, showcasing a displacement of global leadership and cooperation that compounds America’s absence.[13] Taken together, RMB use may increase both in terms of everyday acceptance and in large-scale trade settlements, if the RCEP lives up to its promise.

Headwinds Abound: A Political Perspective

While China pushes public diplomacy with the BRI, international adoption and widespread use of the RMB has, to a degree, been stymied by its own geopolitical actions. Growing mutual distrust between China’s regional and global trading partners undermines its ambition to lead by example. Open and unresolved disputes – including territorial issues in the South China Sea and on the India-China border, the status of Hong Kong, the relationship with Taiwan, and the ongoing contention with the United States – all have a negative impact on RMB internationalization.

For example, the latest changes to Hong Kong’s Basic Law were lambasted for undercutting local legal structures under One Country Two Systems. Laws and restrictions crafted in Beijing on localities such as Hong Kong, which had assumed great autonomy as a special administrative region, highlights limits to Hong Kong’s independent judicial and adjudicatory processes. International investment is not always tied to macro-political movements but as the United States ends Hong Kong’s special trading status under the Trump administration’s pressure, it may become so. As recently as this year, Hong Kong represented the beating heart of financial action and a crown jewel of Chinese international economic might. Hong Kong is at the forefront of RMB internationalization and is the global hub for offshore investments. In the event civil unrest over issues pertaining to the Basic Law persist, then Chinese leadership risks upsetting a delicate economic powerhouse that benefitted both Chinese traders and the world.[14]

Amid this geopolitical backdrop, Beijing’s central policymakers gambled when directly taking charge of Hong Kong’s protests this summer. Their heavy-handed actions revealed the lengths Beijing would go to maintain social harmony and unity. As noted, Hong Kong’s presence and influence on China’s financial growth is outsized. The crackdown on Hong Kong dissidents raises concerns about the city’s future as a global financial center. A brain-drain of talent, business leadership, and even cultural influence due to a perception of the absence of rule of law could tarnish China’s hard-sought image of a country boasting ease of conducting international business. At the same time, it provides opportunities for rivals looking to shape the narrative that China’s commitment to an open and fair playing field for businesses and international partners is disingenuous.[15]  

Increased adoption of the RMB as a medium of exchange or currency relies on neighboring countries and major trading partners seeing China and the RMB as a safe, stable, and reliable haven with little geopolitical risk – a difficult task if the very partners who would benefit the RMB are turned into adversaries over natural resources or unresolved political conflict. China’s rapid military modernization, long presented as part of a drive for independence and deterrence, is now increasingly perceived as aggressive by the United States, Japan and others.[16] Hypersonic missile development, dozens of new naval surface and submarine vessels, and the reorganization of the People’s Liberation Army (PLA) marine corps alone present one half of the equation. When such military developments are coupled with the lack of diplomatic progress on issues such as Taiwan’s status, maritime activity in the South China Sea, or territorial disputes with India, Chinese policymakers must rely on military force, or threats thereof,[17] to pursue their own agenda. Additionally, China’s renewed embrace of the North Korean regime has only served to alienate South Korea and Japan. The threat of hard power use, whether on the border of India or in a potential miscalculation in the South China Sea, is a heavy risk to China’s push in adopting the RMB more widely.

Another angle to consider is the how the U.S.-China relationship itself directly impacts China’s ambition to displace the USD’s dominance with the RMB. The Trump administration’s initiation of the recent trade war revealed previously unaddressed concerns. International partners may have no choice but to pick sides,[18] and currencies will be another tool of a great power rivalry. A prime example of the dueling systems was a shift to settling bilateral oil contracts with nations such as Venezuela in 2019[19] in RMB, or Petro-yuan, rather than USD. There is potential to break the United States’ dominance on financial leverage in foreign policy; conversely, such acts could create confusion for businesses and economies juggling conflicting agendas from Beijing or Washington.

The short-term risks of a tumultuous U.S.-China relationship raise the specter of deglobalization,[20] wherein the global market fragments. On one hand, that could favor an internationalized RMB as the currency of choice among like-minded, closed-system trading partners deeply reliant on Chinese trade for domestic growth.[21] On the other, such deglobalization would undercut the innovation engine of twenty-first century business and technological progress that even China’s economic corporate juggernauts have relied on. China itself leveraged its ascent in technology and manufacturing on the fundamental freedoms of cross-border, transcontinental development, and deployment of the ABCD’s: artificial intelligence, block-chain technology, cloud computing, and big data. Fragmentation of the global digital economy would be devastating to markets in every corner of the world, forcing each player to reevaluate whom it could do business with and how.

The Way Forward: Prospects and Challenges

Although it has made remarkable progress in recent years, the RMB has a long way to go before replacing the USD as the world’s dominant reserve currency. While serving as a medium of exchange and store of value, the RMB is falling behind in performing as the unit of account for pricing global commodities. To be accepted as a truly global currency, the RMB should be freely convertible (liquid), held as a reserve currency (financial asset), and used as a unit of account for the invoicing of global commodities. The RMB has performed well as a currency for trade settlement and for central banks as a global reserve currency, but it has lagged as a currency unit for commodity pricing. The PBOC, under the direction of the Chinese Communist Party (CCP), will have to liberalize capital market and remove capital controls to help expedite RMB internationalization. Moreover, China must override the functional incompatibility of monetary policy goals prioritizing institutional autonomy, capital flows, and fixed exchange rate (Mundell-Fleming trilemma) if it wants to be an integral player in the global financial system. Now China maintains a tight ‘market influenced’ control on the RMB exchange rate, while fluctuating its limits on free flow of capital and leaning on a balance of trade payments in its favor. Chinese policymakers will have to radically reevaluate one of those pillars for the currency to gain traction in international markets.

RMB internationalization is a strategic attempt by the CCP to expand the global reach of China’s currency. However, instability and lack of global trust in the political system persists, and investors are increasingly concerned about the dangers of state control and the PBOC’s independence. These issues will remain as problems for RMB internationalization.

RMB adoption boils down to trust. Those who use the RMB must be convinced that reported financial data accurately represents the strength or weakness of China’s domestic economy. The Chinese financial system is heavily regulated and subject to political control. For cross border capital flows, the capital market should be deregulated thereby free from political hindrances. Further, there must be trust that an RMB-led financial system, or even a convenient digital RMB-led system, would not be manipulated or fixed for China’s benefit alone.

Geopolitical risk, such as instances of China walking back on promises and using force in domestic and regional disputes, will reverberate in financial markets and prompt rivals to take advantage of China’s currency as another realm of great power competition. Increased awareness that such moves will directly impact the status and adoption of the RMB abroad is critical. China faces an uphill battle in advancing the RMB’s position within the global currency hierarchy. Foreseeing continued friction in its adoption, the near term will see a cemented multi-currency global reserve system consisting broadly of the USD, the euro, and the RMB. Lessons learned from the Asian financial crisis (1997-98) suggest that China should pursue a gradualist approach to currency internationalization. This conforms to Deng Xiaoping’s advice of “crossing the river by feeling the stones.”[22] China is still fording – but the river is now deeper and swifter.

About the Authors

Jacob Kurien is a Resident Professor of International Economics at the Johns Hopkins University Center for International Studies (SAIS) in Nanjing, China. His previous experience in the field of teaching economics has brought him to the United States, India, Sri Lanka, Benin, Thailand, and Australia.

Bernard Yudkin Geoxavier is the Upper School Assistant Principal at Rowland Hall School in Salt Lake City, Utah, and is a First Lieutenant, Logistics Officer, in the Utah Army National Guard.

Endnotes

1. Paul Krugman, "The International Role of the Dollar: Theory and Prospect,” in Exchange Rate Theory and Practice eds. John F.O.Bilson and Richard C. Marston (University of Chicago Press, 1984), 261-278.

2. Jens Stoltenberg, NATO Secretary General, Remarks on Launching #NATO2030 – Strengthening the Alliance in an Increasingly Competitive World, June 8, 2020, https://www.nato.int/cps/en/natohq/opinions_176197.htm.

3. Central Committee of the Communist Party of China, “Chapter 50: Improve the New System of Opening Up,” in The 13th Five-Year Plan for Economic and Social Development of the People’s Republic of China, (Central Compilation and Translation Press, 2016 – 2020), 144-146.

4. Jacob Kurien and Bernard Geoxavier, “Roadmap for the RMB Internationalization: Navigating the Rise of China’s Currency,” Harvard Kennedy School Review, May 2, 2013, https://ksr.hkspublications.org/2013/05/02/a-roadmap-for-rmb-internationalization-navigating-the-economic-and-political-challenges-to-the-rise-of-chinas-currency/.

5. Somik Lall and Mathilde Lebrand, “Who Wins, Who Loses? Understanding the Spatially Differentiated Effects of the Belt and Road Initiative,” Journal of Development Economics, Volume 146, 6, May 2020.

6. The Achievement of BRI, Xinhua Press Release Video, April 26, 2019, http://english.www.gov.cn/news/video/2019/04/26/content_281476629540766.htm.

7. Eleanor Albert, “China’s Big Bet on Soft Power,” Council on Foreign Relations, February 9, 2018, https://www.cfr.org/backgrounder/chinas-big-bet-soft-power.

8. Henry M. Paulson, “The Future of the Dollar,” Foreign Affairs, May 9, 2020, https://www.foreignaffairs.com/articles/2020-05-19/future-dollar.

9. Prableen Bajpai, “The 5 Largest Economies in the World and their Growth in 2020,” January 22, 2020, https://www.nasdaq.com/articles/the-5-largest-economies-in-the-world-and-their-growth-in-2020-2020-01-22

10. “Beyond Borders: China Opens up to the World,” RMB Tracker, SWIFT, June 2019.

11. Chris Chen and Seth Peterman, “Chinese Renminbi Internationalization: Guide to Recent Developments,” PNC Insights, November 19, 2019, https://www.pnc.com/insights/corporate-institutional/go-international/chinese-renminbi-internationalization-guide-to-recent-developments.html

12. Jia Chen, “PBOC to Promote Further Cross-Border Use of RMB,” August 17, 2020, http://global.chinadaily.com.cn/a/202008/16/WS5f38a95ba31083481726091e.html.

13. Keith Bradsher and Ana Swanson, “China-Led Trade Pact Is Signed, in Challenge to U.S.,” The New York Times, November 15, 2020, https://www.nytimes.com/2020/11/15/business/china-trade-rcep.html.

14. Tianlei Huang, “Why China Still Needs Hong Kong,” Peterson Institute for International Economics, July 15, 2019, https://www.piie.com/blogs/china-economic-watch/why-china-still-needs-hong-kong.

15. Laura Westbroof, “Fears of Hong Kong brain drain amid months of violent anti-government protests and concern of national security law,” South China Morning Post, June 6, 2020, https://www.scmp.com/news/hong-kong/society/article/3087795/fears-hong-kong-brain-drain-amid-months-violent-anti.

16. Nose Nobuyuki, “Why Hypersonic Missiles Are Changing the Defense Landscape,” Nippon.com, October 12, 2020. https://www.nippon.com/en/in-depth/d00613/.

17. Kristen Huang, “Chinese Government Drops References to ‘Peaceful’ Reunification with Taiwan,” South China Morning Post, May 22, 2020, https://www.scmp.com/news/china/politics/article/3085700/chinese-government-drops-references-peaceful-reunification.

18. Kenneth Rapoza, “China Is Nowhere Near Replacing The Dollar,” Forbes, April 23, 2020, https://www.forbes.com/sites/kenrapoza/2020/04/23/china-is-nowhere-near-replacing-the-dollar/?sh=5dfe9024dfdf.

19. Mayela Armas, “Exclusive: Facing U.S. Sanctions, Venezuela Offers Suppliers Payment in Chinese Yuan,” November 27, 2019, https://www.reuters.com/article/us-venezuela-china-yuan-exclusive/exclusive-facing-u-s-sanctions-venezuela-offers-suppliers-payment-in-chinese-yuan-sources-idUSKBN1Y20FA.

20. Sagatom Saha and Ashley Feng, “Global Supply Chains, Economic Decoupling, and the U.S.-China Relationship, Part 2,” The Jamestown Foundation, China Brief, Volume 20, Issue 8, May 1, 2020.

21. Enea Gjoza, “RMB Internationalization: Implications for U.S. Economic Hegemony,” Belfer Center for Science and International Affairs, Harvard Kennedy School, May 2018, https://www.belfercenter.org/sites/default/files/files/publication/PAE%20Gjoza%20-%20web.pdf.

22. “The Origins of ‘Crossing the River by Feeling the Stones,’”《‘摸着石头过河’的来历》.”“摸着石头过河”的来历. Guangan Daily 广安日报, April 12, 2018, http://cpc.people.com.cn/n1/2018/0412/c69113-29921565.html.