Download Globalization of the Chinese Yuan

Globalization of the Chinese Yuan
October, 2009
SAMSUNG ECONOMIC RESEARCH INSTITUTE,
BEIJING OFFICE
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1. Global Financial System Reforms
□ The ability of the current global financial system in overcoming the current financial
crisis is limited.
- The fundamental problems are global imbalance and excessive liquidity. To
prevent the recurrence of a similar financial crisis, the global financial order
should be reformed and reorganized.
- The ongoing crisis illuminated weakness in the global financial system, i.e. a
lack of proper supervision, which roiled the financial market and sent the real
economy into recession.
- Emerging economies and developing countries want the decision-making
process at international financial organizations to be reformed. They believe the
institutions do not represent their advances in the international community.
ㆍ At the International Monetary Fund (IMF), developed countries and
emerging countries have 57.9% and 42.1% of voting rights, respectively (40.5%
before April 2008).
ㆍ The US has a veto right at the IMF and exercises absolute power in selecting
the World Bank president.
Table 1. Portion in the Global Economy by Country and Voting Right in the IMF (2008)
Emerging
Countries
Portion in the
Global GDP
IMF Voting
Right
Developed
Countries
Portion in the
Global GDP
IMF Voting
Right
China
7.25%
3.66%
The US
23.50%
16.77%
Russia
2.36%
2.69%
Japan
8.11%
6.02%
India
2.16%
1.89%
Germany
6.08%
5.88%
Mexico
1.87%
1.43%
UK
5.08%
4.86%
Brazil
2.41%
1.38%
France
4.74%
4.86%
Korea
1.78%
1.33%
Canada
2.44%
2.89%
Source: “World Bank’s World Development Indicator,” IMF.
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□ The US dollar is in a Triffin’s Dilemma.1
- The US risks massive current account deficits to meet the global demand for
dollar liquidity. This is the one of causes in the dollar’s decline in credibility.
□ The hegemonic status of the dollar as an international currency faces challenges.
- The US economic policy isn’t compatible with the international status of the
dollar.
ㆍ The dollar is used to settle 70% of the international trade transactions.
ㆍ Any change in macroeconomic and foreign exchange rate policy of the US
affects economies around the world.
ㆍ The US’ national interest has priority over its international interest, if a
choice has to be made.
- Some countries have given up the dollar as trade payment currency and used
their own currency or currencies of their trade partners for payment. Other
countries have adopted a substitute to the dollar.
ㆍ Brazil, Argentina, China and Russia decided to use their own currencies for
payment of bilateral trade.
ㆍ Malaysia, Bahrain, Libya, Morocco and Iran started to use Islamic Dinar for
trade payment instead of the dollar in 2003.
□ The US, Europe, Japan and emerging economies have different opinions about
international financial order.
- Developed countries hope to maintain their own vested rights.
ㆍ The US tries to maintain three main pillars of the financial order: dollardominated financial system, the World Bank and the International Monetary
Fund.
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When the US suffered current account deficits for several years in the 1950s, worries arose over how
long the deficits would last and who would provide international liquidity when the US current account
turns positive. Yale professor Robert Triffin said, in a speech to Congress, that the world economy could
contract if the US stops liquidity to the global economy to reduce current account deficits. But if the US
current account deficit continues, the dollar value would fall and the credibility of the dollar as the reserve
currency would fall too, collapsing the fixed exchange rate system. In short, there is no real solution to the
situation. The dollar can’t satisfy two conditions as an international key currency, which is ample
liquidity and credibility as a reserve currency.
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ㆍ The Europe claimed that the status of the IMF should be strengthened by
establishing new Bretton Woods system, intervening in markets, strengthening
financial supervision and reforming international financial institutions.
ㆍ Japan hopes to raise the status of the yen while maintaining dollar-centered
financial order.
- Developing countries and emerging economies is calling on the international
community to reflect changes in the global economy by reforming the world
financial order.
□ China is speeding up to adjust its strategies to globalize the financial order.
- The Chinese government is trying to reduce dependency on the dollar in terms
of trade, overseas investment, management of foreign currency reserve and
having a bigger voice in global financial affairs.
- China's strategies to globalize its financial industry include globalization of the
yuan,2 regional currency cooperation, reorganization of the global financial
order and reform of the IMF.
ㆍ The Chinese government signed bilateral currency swap deals and
introduced the yuan as a trade payment currency in some of its local areas, in
an efforts to globalize the yuan.
ㆍ Zhou Xiaochuan, China’s central bank governor has released a proposal
calling for the overhaul of the global monetary system and replacing the
world’s main reserve currency with the Special Drawing Right (SDR).3 In
addition, he expressed China's hope to boost its voting right in the IMF.
□ One of the Chinese government's main goals is to make the yuan an international
currency.
2
Globalization of a currency refers to circulating it beyond its national borders and having it recognized
as a payment and reserve currency for international transactions.
3
The remark of Chinese central bank governor regarding the SDR is regarded as mere rhetoric for now.
China has no alternative other than the US dollar in managing its foreign currency reserve. In fact, the
amount of the US Treasury purchased by China is increasing.
4
- Due to difficulty in reforming the international financial order, the Chinese
government has made globalization of the yuan a priority.
ㆍ To reorganize the international monetary system and reform the IMF, panglobal consensus is necessary. Regional currency cooperation will need panEast Asia consensus.
- Sensing that creating a key currency is difficult due to the objection from the
US, China directed its efforts on the globalization of the yuan.
2. Opportunity and Challenge of the Yuan's Globalization
Yuan’s Globalization: Opportunity
□ Discussion about a new currency regime accelerated the yuan's globalization.
- Since the global financial crisis weakened the credibility of the current
international monetary system, the Chinese government is seeking solutions
such as diversification of the system.
- Power balance in US, Europe and Asia is essential to stable and sound growth
of the global economy and the financial industry.
ㆍ Asia is expanding its influence in the global economy, accounting for onethird of the global GDP.
- Over the long term, Chinese yuan will likely replace Japanese yen as a
representative Asian currency and rival to the US dollar and the euro.
ㆍ Since Japan’s capital market isn’t well prepared for the market opening and
Japan isn’t free from US influence politically or economically, China is
expected to outpace Japan to become the world’s second-largest economy.
□ The global financial crisis is accelerating the globalization of the yuan.
- China risks massive losses while managing the foreign currency reserve.
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ㆍ There is possibility that the dollar’s value will decline as the US buys
Treasury bonds and issues more dollars in an effort to overcome the global
financial crisis. To minimize the losses to China, which bought a huge amount
of US Treasury bonds, China needs expand the role and the scope of the yuan in
international trade.
- Under the current situation, the globalization of the yuan is regarded as a timely
measure.
ㆍ Since the US has massive trade deficits and current account deficits together
with large issuance of the dollar, expectation of dollar’s devaluation grows.
Countries are in consideration of investing in foreign currencies with a high
investment potential to raise the value of their foreign currency reserve.
ㆍ China’s large foreign currency reserve and positive expectation of the yuan
appreciation increase the possibility that many countries will look at the yuan as
their reserve asset.
ㆍ Since a massive amount of dollar flowed out of the emerging countries amid
the financial crisis, emerging countries often face dollar shortage in trading with
China. This is an opportune time for China to introduce yuan-based crossborder trade payment.
□ China’s continuous economic growth is paving the way for globalization of the yuan.
- China’s strong economic performance is expected to raise international
credibility of the yuan and help the economy to overtake Japan as the world’s
second-largest economy in late 2009.
ㆍ If China maintains 7% to 9% annual economic growth and the US continues
to grow by 3%, China’s economy will likely exceed that of the US around 2038.
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Figure 1. China’s Portion in the Global Economy (From 1990 to 2010)
(Unit: %)
(Unit: %)
10
16
China's portion in the global economy
Growth of China's GDP
Average GDP growth of the global economy
9
8
14
12
2010F
2009F
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
-4
1997
-2
0
1996
0
1
1995
2
2
1994
4
3
1993
6
4
1992
8
5
1991
10
6
1990
7
Source: National Bureau of Statistics of China; IMF World Economy Outlook 2009.
- China’s enhanced global status in the cross-border trade created favorable
condition for the yuan’s localization and globalization.
ㆍ In 2007 China ranked second in terms of exports, behind Germany, and third
in terms of imports after the US and Germany.
ㆍ China has trade deficits with many East Asian countries. If the yuan is
introduced as a payment currency in trade with these countries, the use of the
yuan can be expanded.
ㆍ China’s overseas investment will likely grow further.
□ The global status of the yuan was greatly enhanced.
- The yuan, which has been stable for a long time, meets requirements as a free
convertible currency.
ㆍ According to the IMF’s 2008 World Economy Outlook, inflation level of
China from 1980 to 2006 is similar to those of major industrial countries.
ㆍ According to the real effective exchange rate trend from January 1994 to
March 2009 compiled by the Bank for International Settlement (BIS) the yuan
exchange rate is relatively stable. It was less volatile than those of other
western and BRICs countries.
- In terms of the M2 circulation, the yuan is the world’s fifth-largest currency.
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ㆍ The yuan is the only currency among the world’s five major currencies
comprised of euro, dollar, yuan, pound and yuan (based on M2 circulation),
which cannot be freely converted.
Figure 2. M2 Circulation by Country
(Unit: US$ Trillion.)
14, 000
12, 000
10, 000
8, 000
6, 000
4, 000
2, 000
0
Kuwait
U.A.E.
South Africa
Denmark
Norway
Switzerland
Brazil
Mexico
India
U.K.
Japan
E.U.
Source: Global Money Supply 2008 <http://www.safehaven.com/article-10746.htm>.
□
The China’s financial market achieved considerable growth.
- Improvement in China’s financial system and its maturity contributed to the
yuan’s globalization.
ㆍ China has modernized its financial system by reforming the banking system
and setting up legal principles in management of the financial institutions.
ㆍ China introduced market mechanism while changing its foreign currency
management system4 from direct to indirect one. In addition it initiated spot
exchange transactions between the yuan and other currencies such as dollar,
yen and Hong Kong dollar and futures trading of the yuan.
- The Chinese government is attempting to turn Shanghai into an international
finance center commensurate with its elevated global status.
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The main problem of China's foreign currency management is that it is a centralized management
system. If an individual or a company earns foreign currency, it should sell it to the central bank. Due to
this centralized foreign currency management, China has a vast foreign currency reserve worth US$2
trillion. This is one of headaches of the Chinese economy.
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Yuan’s Globalization : Challenges
□ China’s move to globalize the yuan will likely face challenges from member countries
of the current international monetary system.
- The member countries naturally try to protect the current status of their
currencies in the global economy.
ㆍ If the US feels that its political and economic interest could be hampered by
China’s efforts to make the yuan into an international currency, the US will
interfere as it did with Japan’s move to globalize the yen in the 1990s.
□ Due to shortcomings of the Chinese economic structure, there are no direct and
effective channels and methods to export the yuan.
- The currency of a nation is usually exported through trade deficits or foreign
direct investment. China is a country with trade surplus, which doesn’t change
over the short term. Therefore, this structural problem will make it difficult for
China to export the yuan.
- China's foreign direct investment is increasing rapidly but it still remains small.
ㆍThe accumulative amount of US overseas investment by late 2007 reached
US$2.95 trillion while that of Chinese overseas investment stood at US$117.9
billion.
□ The Chinese government doesn't have proper supervision, which prevents financial
risks resulting from the yuan's globalization.
- To globalize a currency, a country needs to improve its capability to fend off
financial risk.
ㆍA financial crisis occurs when the weakness of a key currency country is
attacked by international speculative forces who have a large amount of the
targeted currency.
ㆍA key currency country needs to have an effective financial supervisory
system and experience in macroeconomic coordination in order to respond to
changes in the economic environment and financial industry at home and
abroad.
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ㆍHowever, China's financial supervisory system is still in its infant stage.
□ Since the Chinese financial industry is still behind in terms of development and
liberalization, globalization of the currency is far from being realized.
- Strict regulations of the capital account are an obstacle to yuan's globalization.
ㆍTo become an international key currency, overseas investors must be able to
acquire and convert the yuan to other currencies easily. To satisfy this
precondition, the financial market should ease restrictions of the full
convertibility of the yuan.
ㆍChina's strict control on capital account has made the Chinese economy less
affected by the global financial crisis than US and European countries.
Therefore, liberalization of China's capital account will take a considerable
amount of time.
- Since China has fewer investment products than other major industrial countries,
the country provides few channels for investors to invest in and hoard the yuan.
ㆍVarious financial products and an open financial market should be provided to
currency investors so that they can yield high profits with currency investment.
ㆍChina is far behind advanced countries in terms of total asset amount, total
transaction volume and kinds of financial products.
3. Current Status and Projection of Globalization of the Yuan
Current Status of Globalization of the Yuan
□ Circulation of the yuan is increasing abroad.
- With a strong growth of the Chinese economy, and stabilized exchange rate of
the yuan, neighboring countries recognized the yuan as the settlement currency
in trade transactions.
· With intensified competition between Hong Kong and Macao, the conversion
and the use of the yuan have become common. Over 70 billion yuan is in
circulation in Hong Kong.
· The yuan practically emerged as the regional currency, being used as the
currency of settlement in Vietnam, Russia, North Korea, Myanmar, and Laos.
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□
The yuan is in infant stage of globalization
- The circulation of the yuan is limited abroad.
· According to the State Administration of Foreign Exchange, monetary supply
(M2) of the yuan amounts to about 2 trillion yuan. Among them, 100 billion
yaun is circulated overseas, and 20 billion yuan is held abroad, accounting for
just 1% of the total money supply.
Table 2. Composite Index of Globalization of the Dollar, Yen, Euro, and Yuan
Percentage Percentage of
Internatio-
Scope of Percentage
of currency
currency in
in
international
international
securities
loan market
market
nal
Index
circulation of overseas
Trade
abroad
circulation
payment
Percentage
of currency
in direct
investment
The
amount of
holdings by
other
countries
The degree
of
globalizetion
Dollar
100.0
66.7
60.0
93.4
44.0
19.5
64.0
100.0
Euro
86.5
0.9
20.0
4.0
19.0
39.9
6.0
39.4
Yen
73.0
0.4
5.0
1.0
23.0
4.0
20.0
28.2
Yuan
8.8
1.1
0.0
0.0
0.0
0.0
0.0
2.0
Source: Task force team in charge of globalization of the yuan in People’s Bank of China
- Globalization of the yuan is in initial stage.
· The yuan is infrequently used in international trade and financial transactions
abroad. The globalization of the yuan in global loan and stock markets is low.
· If globalization of the dollar is 100, then the globalization of the yuan is two,
much lower than that of the euro, and the yen, which are 40 and 28.2,
respectively.
Capital Account Liberalization and Projections on Globalization of the Yuan
□ China is focusing on expanding yuan circulation abroad to use it as the settlement
currency in trade transactions with neighboring countries.
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- The yuan is the settlement currency between China and its neighboring
countries, and model areas have been set up.
· China signed a currency settlement agreement with the central bank of eight
countries including Vietnam, Mongolia, Laos, Nepal, Russia, Kyrgyzstan, North
Korea, and Kazakhstan.
· In April 2009, State Council of China announced that the yuan will be used as
the settlement currency in trade transactions between Chinese cities, including
Shanghai, Guangzhou in Guangdong province, Shenzen, Zhuhai ,Dongguan and
Hong Kong, and Macao.
- Some trading partners of China accepted the use of the yuan as the settlement
currency in trade transactions.
· Most developing countries affected by the financial crisis are in short of the
dollar and allowed the use of the yuan as the settlement currency in trade.
- The Chinese government is providing yuan-denominated foreign aid and is
reviewing whether to allow beneficiaries to use the yuan in Hong Kong’s
financial market.
- China is expanding the circulation of the yuan by settling trade transactions with
countries signing a bilateral currency swap in the yuan.
□ In the short term, China is expected to keep a lid on allowing free conversion of the
yuan into other foreign currencies in capital account.
- For free conversion of the yuan in capital account, certain requirements are
necessary.
· Requirements include sound macroeconomic policies, vast foreign currency
reserves, competitive businesses and banks, stable financial systems, an
advanced financial market, and a perfect financial management and supervisory
system.
- As of now, China cannot meet those requirements.
· With a weak financial system, poor financial management and supervision of
the central bank, and stalled development of financial market in China, a
massive inflow of foreign capital can create a bubble, and a large outflow of
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foreign capital can take a toll on the yuan’s exchange rate.
□ The yuan is likely to emerge as a local settlement currency in the short term.
- Economic cooperation of Northeast Asia facilitates the adoption of the yuan as
the settlement currency.
· For the expansion of trade and investment liberalization in Northeast Asia,
local currency is necessary.
· China signed a currency settlement agreement with several other countries, and
actively participated in establishing currency union of ASEAN plus three
nations (China, Korea and Japan).
□ China is prepared to make the yuan a local reserve currency, and realize the free
conversion of the yuan in capital account balance.
- China is implementing gradual and planned liberalization of its capital account
balance, and creating an environment to realize free conversion of the yuan.
· China is taking measure to lift restrictions on overseas direct investment.
· China implemented Qualified Foreign Institutional Investors (QFII) in July
2003, opening its market to foreign capital. In April 2006, China implemented
Qualified Domestic Institutional Investors (QDII), and in August 2007, China
allowed individual investors to invest in overseas stock markets.
· From 2005, China began to allow international financial institutions, including
the Asian Development Bank, to issue yuan-denominated bonds inside China.
- China is trying a free conversion of the yuan by developing Hong Kong as an
offshore market of the yuan.
· Developing Hong Kong as an offshore market of the yuan would help address
the lack of openness in the China capital market.
- By developing Shanghai as the hub of global finance, China aims to develop its
financial market in line with the city’s international stature.
· There is a need for local and foreign banks with good risk management
capability to set up an offshore financial service of the yuan to meet the
demands of risk management of the yuan abroad.
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- With the progression of globalization, it is projected that free conversion of the
yuan in capital account will be realized in five to 10 years.
□ In the mid- to long-term, there is the possibility that the yaun will be developed as not
only the local currency but also as the world’s second reserve currency.
- The development and maturing of the Chinese financial market facilitates the
adoption of the yuan as a regional currency.
· The establishment of Shanghai financial center will guarantee free conversion
of the yuan in capital account by 2020. The development of financial products
traded in the yuan will contribute to the adoption of the yuan as a local reserve
currency.
- When conditions are met, the yuan is likely to become a second reserve
currency.
· If China maintains strong growth and is not left behind in the competition with
the yen, there is a high possibility that the yuan will become a second reserve
currency like the yen and the pound.
□ In the long term, with the rise of the Chinese economy, globalizing the yuan is
necessary, but due to several restrictions, it is likely that the dollar and the euro will
maintain their position as the reserve currency at least for the next 10 to 20 years.
- During that time, the yuan is projected to expand its influence as the local
settlement currency.
4. Effect of the Globalization of the Yuan
Positive Effect of Globalization of the Yuan
□ Globalization of the yuan will raise China’s standing in the world, and strengthen
China’s influence and say in the global economy.
- It will promote China’s trade and foreign investment, reduce currency exchange
risk exposure of Chinese companies, and avoid excess liquidity.
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- It will also enhance competitiveness of Chinese financial institutions, and raise
the profile of Chinese capital and financial market.
· Wider use of the yuan in international transactions will provide greater
opportunity for Chinese financial institutions to do business.
□ China can generate revenues such as seigniorage5 and inflation tax
- Seigniorage is the biggest benefit of the globalization of the yuan. It is divided
into direct and indirect revenue.
· Direct revenue of seigniorage6 derives from additional supply of money, and
further revenue derived from asset management.
· Seigniorage promotes international financial transactions, and increases the
size and efficiency of financial market based on reduction in exchange risk, and
convenience in financial transactions.
- International currency creates inflation tax revenue for a currency-issuing
country.
· Devaluation of international currency promotes exports, and gives economic
disadvantage to holders of international currency-denominated bonds. Revenue
derived from devaluating international currency is called inflation tax revenue.
· China which holds US$2trillion in foreign currency reserves suffers from an
inflation tax as it shoulders the burden of providing free loans to foreign
governments. Globalization of the yuan will reduce the tax.
Cost of Globalization of the Yuan
□ Globalization of the yuan would have repercussions on the financial stability and the
Chinese economy.
- It could undermine the stable economic development.
· It will link the Chinese economy with the world economy more closely. Thus
the global economic crisis and inflation will have a bigger impact on China.
5
Seigniorage is the benefit that currency-issuing countries get from the difference between face value of
a note, and the cost of producing and distributing it.
6
Countries with foreign currency reserves in dollars are keeping the US interest rate and current account
deficit at a low level by buying dollar-denominated bonds. Revenue comes from differences in interest
rates between when countries buy US bonds or not.
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· It could cause the revaluation of the yuan, and undermine the competitiveness
of manufacturing sector in China, causing losses to foreign exchange assets.
□ It could make it harder for the Chinese government to make macroeconomic
adjustments.
- China currently has a command economy controlled by the government. The
globalization of the yuan will undermine the control of the government, and that
is why some people in the government may question globalization of the yuan.
- There is the possibility that wide large circulation of the yuan in the
international financial market could hinder the Chinese government’s domestic
e monetary policy.
· A tight monetary policy to control inflation will lead to interest rate hikes in
China. That will stimulate yuan holdings abroad and undermine China’s
monetary policy.
- It will make it harder for the government to manage and supervise the financial
system.
· There is the possibility that illicit funds could be circulated abroad, making it
hard for the government to monitor the demand and distribution of cash abroad.
5. Suggestions
□ Globalization of the yuan should be realized on a gradual basis, starting first in Asia.
- China should enhance the influence of the yuan in Asia.
· China should promote the yuan’s stature in regional trade by participating
actively in regional monetary cooperation, exporting the yuan as the settlement
currency, and conducting offshore financial business by utilizing the status of
the Hong Kong international financial center.
- The yuan should go from a regional currency to an international currency.
· China should expand the circulation of the yuan into overseas investments and
financial sector by realizing the free conversion of the yuan.
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□ China should seek harmony in the process of globalizing the yuan.
- The yuan should cooperate closely with the yen, and have a good relation with
the dollar and the euro.
· In every stage of globalization, the yuan will have conflict of interest with the
yen. Whether the yuan can cooperate with the yen in trade and financial sector
can be an essential factor in the globalization of the yuan.
· There is a concern that the withdrawal from the conventional exchange rate
system would harm the Chinese economy.
□ It is important to combine the function of the market and the government.
- In the process of globalizing the yuan, it is necessary for the government to
promote various policies.
· There were market changes and policy promotions in the globalization of the
dollar and the yen.
· Circulation of the yuan in neighboring countries is the result of market
function, but for the globalization of the yuan, the government should create a
suitable environment by participating in regional economic cooperation, and
establishing bilateral free trade areas.
- It is important to maintain effective, independent monetary policies.
· After globalization of the yuan, exchange rate will fluctuate in the international
market, and internal and external factors will affect the demand of the yuan,
complicating the money supply of the central bank.
· By strengthening the supervision of money flow and maintaining an
appropriate level of foreign exchange, China can strike a balance between
independence and effectiveness of its monetary policy.
- China should gradually open its financial market, and streamline its
management and supervision of its financial system.
· Strict foreign exchange supervision system is disadvantageous for
globalization of the yuan. On the other hand, financial market opening beyond
the control of the Chinese government could destabilize the financial system
and the national economy, and the Chinese economy will be hurt by any idle
money.
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