As the RMB becomes a global currency, macroprudential issues will need to be ironed out
After four unprecedented months of decline earlier this year, the RMB is once again on the upswing. Its rise has unleashed waves of relief for fund managers across the world who had bet that it would rise against other world currencies. But the RMB’s appreciation should not be entirely surprising. Even at a gradual pace of growth, the sheer size of the Chinese economy is driving forward the popularity of the currency as an investment vehicle, instrument of trade, and even reserve. SWIFT [Society for Worldwide Interbank Financial Telecommunication] has indicated that since the government opened the current account in 2009, the RMB has climbed to seventh place in the ranking of global payment currencies, up from 35th in 2011. This year, the government is on track to redenominate a staggering 25% of its trade in RMB in 2014 alone. And even beyond east Asia, as economist Arvind Subramanian has reported, the RMB serves as a reference currency for an increasingly diverse set of countries including Chile, India, Israel, South Africa and Turkey.
Consequently, the occasional debate on whether the RMB will become an international currency is, for all practical purposes, a sideshow to the more serious deliberations concerning just how internationalisation will proceed (and of course, how fast). And from this perspective, the question of the currency’s future is as much a macroprudential one as it is a macroeconomic one.
Moving to a more liberalised current and capital account potentially bodes a host of advantages for healthier macroeconomic growth. For one, goods bought and sold across borders could be priced more accurately, allowing for more even and sustainable global growth. And as Michael Vrontamitis, head of trade at Standard Chartered, has rightly observed, corporates and cross-border firms should be able to find ways to minimise their foreign exchange risk, diversify credit exposures and investment opportunities, and reduce invoicing costs under existing rules. Plus, these advantages could well increase exponentially as the Chinese economy develops and grows.
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The question of the currency’s future is as much a macroprudential one as it is a macroeconomic one |
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But as with most economic reforms, the devil is in the details. The full internationalisation of a currency, even with a country the size and population of China’s, and with its persistent current account surpluses, does not come with the flick of the switch or automatically. Instead, a sufficiently robust market infrastructure is necessary to support the ultimate exportation of the currency, and to contain the volatility that will accompany capital inflows and greater market speculation. What makes this particularly difficult is that this is not just an economic issue, or a market or regulatory one. It’s all of them wound up in one. Consider just a few of the reforms under consideration:
Once integrating with the global capital markets, and becoming (like their EU and US counterparts) mechanisms for transmitting cross-border credit risk, Chinese bank and shadow bank systems (including trust and wealth management products) will have to meet international leverage and liquidity standards to mitigate the possibility of contagion.
A deep and liquid derivatives market will be required to cabin the volatility of foreign exchange markets (along with greater fluctuations in EU and US financial institutions’ balance sheets, margin requirements and collateral packages).
Payment and clearing infrastructures will have to be developed that meet US, EU and Asia-regional collateral, timing and reporting obligations. RMB settlement in particular will have to be upgraded to meet the growing risks that will arise as the currency’s foreign exchange market expands.
Asset management services will have to serve both outward RMB investment and inward foreign investment by firms whose opportunities have historically been curtailed.
Even RMB denominated investments sold offshore will need to be scrutinised, and subject to rigorous and increasingly harmonious (and credible) accounting standards.
China is already well on its way to tackling many of these challenges, and has made tremendous strides in some areas (like bank capital), even surpassing in some ways its US and European counterparts. But there is still plenty of work to be done, from insufficient investable options for surplus RMB liquidity, to still lax rules on non-bank finance. And international regulators have their own homework as well, a point we at the Atlantic Council are now exploring in a series of projects launched this year with our colleagues at Thomson Reuters, the City of London and Standard Chartered. Authorities at the G20, Bank for International Settlements, and Financial Stability Board have expended considerable effort to track the growth of the RMB (and financial bubbles in real estate). But comparatively fewer resources have focused specifically on the regulatory implications of RMB internationalisation for transatlantic and trans-Pacific financial markets.
The urgency of honing in on the issue now is high. RMB internationalisation is already galvanising investment by and into the world’s largest nation of savers. But as the process intensifies, capital account liberaliation will also, by extension, catalyse frictions with EU and US regulatory approaches and infrastructure in areas spanning trade reporting, clearing standards and messaging systems, asset management, accounting and even credit rating agency regulation. Enhanced collaboration early on between Asia and the west – and even with countries like the US that have yet to establish or court their own RMB clearing banks – will therefore be necessary to prevent gaps and undue regulatory complexity which, if unchecked, could undermine stability and stymie the efficient provision of new financial services.
By Chris Brummer, C Boyden Gray Fellow at the Atlantic Council, and the author of Minilateralism: How Trade Alliances, Soft Law and Financial Engineering are Redefining Economic Statecraft