Internationalization of the renminbi needs to transition to a new development trinity

Initiated in 2009, the internationalization of the renminbi has progressed rapidly, and it has made remarkable achievements.

Cross-border renminbi settlement has advanced rapidly with settlement in the renminbi increasing significantly. According to statistics from the People's Bank of China, the amount of cross-border renminbi receipts and payments was more than 28 trillion yuan ($4.34 trillion) in 2020, a year-on-year increase of 44 percent. The use of the renminbi in cross-border direct investment has also increased.

The offshore renminbi market has also developed rapidly and the variety of renminbi-denominated products has increased, with a growing number of bonds and funds available.

Financial cooperation, such as currency swaps, has also been promoted. By 2020, The People's Bank of China, China's central bank, has signed bilateral currency swap agreements with 40 countries and regions. The financial infrastructure has improved, as a settlement network has been established in which renminbi clearing banks serve as hubs and other financial institutions play a supporting role, based on the cross-border payment system. The first and second phases of the Cross-border Inter-Bank Payment System were launched in 2015 and 2018, respectively, covering more than 160 countries and regions. And the number of renminbi clearing banks now stands at 27 in 25 countries and regions.

The international status of the renminbi has improved steadily and its currency anchoring effect has been partially highlighted. The renminbi was included in the Special Drawing Rights currency basket in 2016, making it the world's fifth largest currency after the US dollar, the euro, the Japanese yen and the British pound. According to the PBOC, more than 70 central banks and monetary authorities have included the renminbi in their foreign exchange reserves. The share of the renminbi in official foreign exchange reserves rose from 1.08 percent in the fourth quarter of 2016 to 2.25 percent in the same period of 2020, according to the Currency Composition of Official Foreign Exchange Reserves database.

From 2009 to 2017, the Chinese government promoted the renminbi internationalization mainly through the trinity of encouraging the renminbi settlement in cross-border trade and investment, developing the offshore renminbi markets such as the Hong Kong Special Administrative Region, and promoting currency-swap cooperation between China's central bank and those of other countries. Although progress has been made, that mode has three hidden problems.

First, while the use of the renminbi for settlement payments has been enhanced, its use in denomination needs to be improved, which is important for the renminbi to become an international currency. The enhancement of its value reserve function is a natural process based on the full development of currency settlement and valuation function. Only relying on trade settlement combined with the offshore market development model cannot truly help the renminbi achieve international currency status.

Second, more attention needs to be paid to the construction of the onshore financial market. The return of the renminbi in circulation overseas is still affected by the insufficiency of diverse channels for investing in renminbi-denominated assets as the offshore financial market mainly provides investment and financing channels for outflows. China's capital account has not yet been fully opened and foreign investors' participation in the domestic financial market, and foreign ownership of domestic financial institutions are still subject to national limits, quotas and strict ratios. Focusing on the construction of the offshore market, while ignoring the opening of the onshore financial market, has hindered the formation of a smooth circulation mechanism for the renminbi both at home and abroad.

Third, the reform of interest and exchange rate marketization has not yet been completed. That has led to differences in the renminbi interest and exchange rates between onshore and offshore markets and can generate speculation in investment.

A transition is therefore needed from the old trinity model to one featuring a new trinity to promote the internationalization of the renminbi.

First, promote the use of the renminbi in commodity futures trading. In March 2018, the Shanghai International Energy Exchange launched China's first renminbi-denominated crude oil futures product open to foreign investors. It has become the world's third largest crude oil futures exchange following Brent Oil and West Texas Intermediate. The development of the renminbi-denominated commodity futures and petroleum trade can be driven by the cooperation between China and countries involved in the Belt and Road Initiative.

Second, accelerate the process of opening-up the onshore financial market and forming a sound interaction between the onshore and the offshore renminbi markets through improving the financial market and providing more renminbi-denominated financial products with greater liquidity for foreign investors participating in investment and financing in China. The government can launch pilot programs in the free trade port and free trade zones to encourage innovative practices and promote cross-border cooperation on the internationalization of the renminbi. Efforts are also needed to encourage the participation of government departments, financial institutions, international financial organizations and enterprises.

Third, boost real overseas demand for the renminbi through opening-up. Cultivating real demand for the renminbi in China's neighboring countries has a good economic and industrial chain foundation. In recent years, the Belt and Road Initiative has provided opportunities and key driving forces for the cross-border circulation and settlement in the renminbi. The signing of the Regional Comprehensive Economic Partnership agreement in November 2020 is also expected to promote the internationalization of the renminbi. While promoting domestic enterprises to make direct investment in regions along the route can promote the use of the renminbi, diversified financing through the Asian Infrastructure Investment Bank, Silk Road Fund and Public-Private Partnerships can boost the use of the renminbi in settlement and denomination.

Zhang Ming is deputy director of the Institute of Finance at the Chinese Academy of Social Sciences, deputy director of the National Institution for Finance& Development, and director of the China Chief Economist Forum. Wang Zhe is a post-doctorate at the Institute of Finance at the Chinese Academy of Social Sciences.

The authors contributed this article to China Watch, a think tank powered by China Daily.

The views do not necessarily reflect those of China Daily.

Contact the editor at editor@chinawatch.cn