Challenges with China’s RMB Internationalization Process

Chinese authorities have been making concerted efforts of late to internationalize its currency (renminbi, RMB) by trying to increase its use in international trade settlement and investment. Their efforts are paying off as international RMB payments and trade settlement have grown rapidly since 2010. The whole process consists of three broad steps beginning with the use of RMB in trade settlement, then investment and then as a global reserve currency. The first step is well underway and has received the most traction of the three – around 10-15% of China’s international trade is settled in RMB at present. China has currency swap agreements with 24 central banks allowing them to directly settle international RMB trade. Use of RMB for investment purposes is still limited due to lack of development of the Chinese capital markets and strict controls imposed by the Chinese authorities. Use of RMB as a global reserve currency is the most ambitious step and likely to take the longest time. At present several central banks have expressed interest for increasing RMB holding as part of their reserve. However, the quantum of holding is small at present and primarily geared towards diversification of foreign assets.

In spite of these developments, there are challenges with China’s efforts to internationalize the RMB. Even though the Chinese currency recently broke into the list of top ten currencies globally, its share is still miniscule (~1%) in total global payments. At a broad level, RMB is mostly used to settle imports, but not exports – roughly a third of imports and less than 5% of exports are settled in RMB at present. Even in imports, invoicing is often done in US dollars while settlement happens in RMB.

A necessary requirement for RMB internationalization is to first make it fully convertible. China is planning to do this first through the offshore markets. Doing the same in the onshore market by opening capital account and liberalizing interest rate regime will be more challenging.

Then there are operational challenges for banks that need to be addressed. New systems and processes will be required to support clearing and settlement of payments in real time by domestic and international players. They also need to support different languages including Chinese, English and other regional ones and to accommodate working hours in different time zones to bring about a truly international system of operations.

These will also require strengthening of China’s anti-money laundering (AML) framework. AML practices in China have been in development for over 15 years, however, the AML regulations were largely inadequate until as late as 2006-07. As a result the internal control systems and company culture at banks in China tend to be inadequate, and they do not go beyond meeting basic regulatory requirements at present.

Given the rapid developments in the RMB internationalization process over the last three years, there has been a lot of enthusiasm and optimism expressed by several players regarding its potential to bring in major changes in the immediate future. However, it is safe to assume from past experiences that China will follow a planned, controlled, and slow but steady path in trying to raise the importance of its currency at a global level. True internationalization of RMB will require fundamental changes on many fronts including regulatory, market infrastructure, political and geopolitical aspects. An intermediate step in realizing the ultimate goal may be to first make RMB a dominant currency at a regional level (ASEAN/Asian). The extent of its adoption at a global level will however be long drawn and closely watched.

About Arin Ray

Arin Ray is an analyst with Celent's Securities & Investments practice and is based in the firm's New York office. Arin's expertise lies in capital markets where he has extensive research experience in exchange trading, clearing and settlement, brokerages, and use of technology in capital markets. In his recent consulting work, he has advised a large European financial services provider to devise their post trade (settlement) strategy, a tier 1 Japanese brokerage in their product and technology strategy, and a leading international exchange in their market entry and growth strategy in Asian markets. He has published research reports on exchange and over the counter trading, exchange strategies, and adoption of trading technology in different sub-segments of capital markets.

Arin has been quoted regularly in the media, including Reuters, Wall Street Journal, Financial Times, Dow Jones, Press Trust of India, Economic Times, Financial Express, Finance Asia, Global Investor Magazine, BusinessWeek, Business Standard, Asian Investor, Pension & Investment, Business Week, and Securities Industry News. In addition, he regularly contributes bylined articles for the financial media; his articles have appeared in The Journal of Trading, Advanced Trading, Free Press Journal, FT Asian Investment, gtnews, and Ignites Asia among others.

Arin received his MBA from the Indian Institute of Management, Bangalore and B.E. in Electronics and Telecommunication Engineering from Jadavpur University. He is fluent in English, Hindi and Bengali.

Speak Your Mind

*