Download Thoughts on the Internationalization of RMB Under Financial Crisis

Thoughts on the Internationalization of RMB Under Financial Crisis
YU Fengqin1, HU Jun2
1. School of economics Shandong Institute of Business & Technology, Yantai, China, 264005
2. School of foreign studies Shandong Institute of Business & Technology, Yantai, China, 264005
[email protected]
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Abstract: Internationalization of RMB is the inner need and objective result of China’s economy
development in the currency field. Utilizing the revised Krugman’s GG-LL model which is the curve
of cost-benefit on Finland’ entrance into EU, it can be proved directly that the benefit of
internationalization of RMB is more than the cost. Therefore, to push on the issue is imperative in the
circumstances of financial crisis. The particular procedures involve convertibility in Capital Account,
establishment of foreign exchange market, and the perfection of the domestic financial market.
Keywords: internalization of RMB, GG-LL model, Convertibility
1.
Introduction
Since 2007, with the widespread of US financial crisis, the requirement of reestablishing the system of
international currency is steady upsurge. Recently, it has been greatly cared by the domestic scholars
that whether RMB can speed up the process of internationalization and has the right of decision-making
in the newly-established international currency system. Through the analysis of GG-LL model as the
theoretical foundation, the thesis puts forward the strategies and measures for internationalization of
RMB, hoping which can play its role as reference in the complicated financial reality.
1.1 The Definition of Internationalization of Currency
Internationalization of currency refers to a process of the full or part of the currency function
(calculation, circulation, settlement, and storage) extends from the original country territory to the
neighbor countries or even the whole world, subsequently transforms as a regional currency or a world
currency.
Internationalization of currency is the result of the improvement of a country’s political status, of the
development of a country’s economic social productivity to certain stage, and of the internationalization
of its economy. Basically speaking, it is the mirror of the economical strength of a country in the form of
currency. On the other hand it will promote further development of economical globalization in this
country.
2.
Analysis on Internationalization of RMB under GG-LL Model
2.1 Krugman’s GG-LL Model
In 1990’s, analyzing the curve of cost-benefit on Finland’ entrance into EU, Krugman produced the
world-famous GG-LL model. Here, with the application scope enlarged and basic hypothesis for the
model modified, it will prove the cost and benefit of the internationalization of certain currency. The
revised hypothesis is as follows:
1. The higher the internationalization of certain currency is, the higher the stability and testability of the
domestic price are.
2. Fixed foreign exchange rate system is adopted
3. The more closely the domestic economy connects with world economy, the more the benefit obtain
from the international currency.
Model as follows:
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Cost\benefit
of
internationaliz
ation
of
currency
GG
LL
θ
Openness of economy
Graphs 1
As graphs 1, the horizontal axis represents the openness degree of economy in a country, the vertical
axis represents the cost/benefit of internationalization of certain currency. LL is the cost line, and GG is
the benefit line. Θ point means the equality of the cost and benefit of internationalization of currency.
GG is a right-upward curve, it stands for the relationship between the openness degree of the economy
and the benefit obtained from the internationalization of currency in a country. The higher the openness
degree is, the more benefit will be obtained from the currency’s internationalization. Because the
arrangement of fixed foreign exchange rate avoids the losses on settlement, trade cost, and the
uncertainty of floating foreign exchange rate. Diminishing marginal utility on cost contributes to the
more benefit with higher openness degree and lower cost on settlement and trade cost.
LL is a right-downward curve, it stands for the relationship between the openness degree of the
economy and losses caused by monetary policy independence in a country. If the openness degree of the
economy is high enough, the uncertainty caused by the adjusting mechanism a country has to give up
when applying fixed foreign exchange rate and independent right on currency policy can be lowered in
the process of internationalization of the currency.
The precondition of the analysis on cost\benefit of internationalization of certain currency is to adopt
fixed foreign exchange rate system. According to Impossible Trinity, provided the capital moves freely,
the independency of currency policy definitely should pay for the application of fixed foreign exchange
rate.
Based on soil erosion rate, this analysis neglects the integrity of financial policy. But it helps to find the
relationship of cost\benefit in internationalization of the currency and make the choice on whether to
adopt it.
2.2 Analysis on RMB under GG-LL Model
The macro-economy in China is basically in line with the hypothesis of this model. Managed floating
exchange rate regime is adopted by RMB, which is still relatively stable. From July of 2005 to June of
2008, RMB/USD had been continuously appreciated. It can be looked as that the pressure of RMB
appreciation arising mainly from the surpluses in international balance of payments during 2001 to 2005
is released. From July of 2008 to June of 2010, the foreign exchange rate of RMB/USD performed
stable and maintained at 6.83 and around, with slight fluctuating.
Based on the analysis of GG-LL model, the higher the openness degree of the economy is, the more
benefit and less cost will be obtained from the internationalization of the currency. Since reform and
opening-up, the achievement of economic development in China has attracted the world’s attention.
From 2001 to 2009, GDP growth rate of China remained an average of 10.05%. In 2009, GDP has
grown into 34.05 trillion, ranking third in the world. With the improvement on economic power, the
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degree of openness is higher and higher, which is the cause-and-effect relation and complement each
other. The criteria on economic openness are generally including international trade and international
investment. Since 1990’s, globalization of economy speed up greatly, not only the international trade has
increased continuously but also the international investment has boomed in faster speed. The rate of
international trade had climbed up from 34.4% in 1996 to 66.6% in 2006; the rate of foreign finance had
grown from 19.66% in 1996 to 50.6% in 2007. All of these statistics exemplify the development and
openness of trade and finance in China. It is easy to decide that the economic openness is high enough
and the benefit is obviously more than the cost in China.
Particularly speaking, if RMB becomes the main international currency for calculation, settlement, and
storage, it would make numerous earnings by issuing the currency and on certain degree, ease the series
of problems arising from the disequilibrium of balance of payment for a long time in China.
Subsequently, the risks lied in the foreign exchange rate when individual invest and finance abroad
would not exist forever. Meanwhile, the status of currency for settlement would provide more business
to the finance organizations in China as well, which will help to form a capital liquidation system cored
as RMB. Besides the economical benefits, internationalization of RMB means the strengthened status of
RMB in the system of international currency, which would improve China’s influence on international
affairs, and give more right of speech to China in the international political stage. For instance, Britain
in the time of gold standard and America in the time of Bretton Woods System had all improved their
power of political influence owing to the internationalization of their currencies.
It is inevitable that more risks would be exposed in macroeconomy and finance system domestically
after the internationalization of RMB such as the efficiency on monetary policy which may lead to the
New Triffin Dilemma between fulfillment of international payability and maintenance of currency credit.
Compared with the earnings, the cost is undertaken within our capacity.
3.
Path Choice on Internationalization of RMB
At present, it is an opportunity for internationalization of RMB. The credit and status of US dollar has
been weakened to some extent in the international finance system after the US financial crisis. EURO
and Japanese Yuen are volatile as well. It provides a chance for China to enlarge the application scope
and enforce the international status of RMB. Under the threats of global financial volatility and
gradually recession of economy, economy in China can be still on the steadily upward trends. Through
the analysis on the above facts, it will be well recognized that RMB totally has such potential to become
a main means of international trade and investment as long as we take measures to push the process of
internationalization of RMB actively.
3.1 Strategies on Internationalization of RMB
The strategies adopted can be summarized as 3 steps including 2 levels.
Firstly, to take 3 steps in extension of territory, those are neighborization, regionalization, and
internationalization, which have a rational order inside: neighborizing RMB and promoting the
circulation of it in the neighboring countries and areas such as Vietnam; then regionalizing the RMB and
improving the status of it constantly in other Asian countries, and making RMB a leading currency in
this region step by step; at last internationalizing it.
Secondly, to take 3 steps in function of currency, that is insistence on the adopt of making payment,
investing, and storing in RMB, which has a rational order: making payment in RMB can increase the
share of RMB in international payment; investing in RMB can become it a main investment currency in
the international financial market; at last, RMB can gradually be developed into international storage
currency.
What should be emphasized is that these steps are not separated with each other but dependent and
intersectional.
In fact, RMB has been accepted widely in the neighboring countries. RMB even circulates instead of its
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native currency in the northeast of Laos, and the furthest distance even to the area of capital of Vientiane.
In the foreign trade between China and Myanmar, cross-border RMB in circulation amount to 10
billions annually. RMB can also be circulated in Vietnam, five countries in mid-Asian, Russia and
Pakistan, and in Kazakhstan. It has become the largest amount of cross-border circulating currency. In
Mongolia, it has taken more than one third of the transaction value in cash in the bilateral trade. In Hong
Kong, it has been treated as the storage currency, and used to set prices and invest in financial capital.
Till June of 2010, the pilots RMB trade payment has increased to 20 provinces within the boundary.
From the above facts, it should be admitted that there exist large demand for RMB in international
market, and it is just round the corner that RMB becomes a regional and international currency.
3.2 Particular Steps in the Internationalization of RMB
3.2.1. To Push on the convertibility in Capital Account
The technique requirement for internationalization of RMB is convertibility in capital account, which is
the basis of the internationalization of certain currency. Given the currency is inconvertible, it will not
be well accepted worldwide and naturally turn into a currency with high risks. All dimensional openness
in capital account is impossible in recent years, while the internationalization of RMB does not need to
wait. On the contrary, to promote the process of it will create conditions for the openness in capital
account.
Realization of convertibility in capital account shows in two aspects: firstly, to loosen up restrictions on
direct investment by domestic organizations, and support more enterprises to “go out” because it is a
good opportunity to invest and merger with low expenses and costs under the global financial crisis.
Secondly, to loosen up restrictions on equity investment by foreign investors, and allow the domestic
organizations to invest in securities market abroad and the foreign organizations to issue RMB securities
and Chinese Depository Receipts (ADR).
3.2.2. To establish the perfect foreign exchange market
Primarily, as a market support, a foreign exchange market with high degree of internationalization is
necessary. Both RMB Convertibility and the formation mechanism for reasonable foreign exchange rate
depend on a perfect and effective foreign exchange market. The foreign exchange market has been
developed quickly since the national united market for interbank established in 1994. On April 9th of
2007, China Foreign Exchange Trade System pushed out the sight, time, and swap trade for RMB/FX.
Since August 17th of that year, interbank FX market has begun the swap business on RMB\US dollars,
Euro, Japanese Yuen, Hong Kong dollars, and Br pound. It has been recognized that the trading volume
is rising continuously on the whole annually as a result of the perfected interbank FX market, innovated
and enriched the products, and improved market scale, liquidity, and standardization. But it is also
realized that compared with the large scale of import & export, capital flows and GDP, the trade scale
and trade types in China foreign exchange market are far from the market demand. Therefore, it is an
important task to strengthen the infrastructure construction of foreign exchange market in the process of
internationalization of RMB.
3.2.3. To Improve the Domestic Financial Environment
The financial environment is always developed in the direction of health and internationalization, but it
is undeniable that there exist many deficiencies in the financial environment in China such as
imperfection of banking system, low efficiency of transnational operation, incapacity of providing
necessary physical carrier for the circulation of international currency, lack of financial products, and
defection of off-shore financial market, so that in order to create positive soft environment for
internationalization of RMB and adapt to the international financial market, the main task for China is to
accelerate the innovation and openness of financial market, and establish a modern banking system and
comparatively perfect finance system as quickly as possible.
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4.
Conclusion
With the development of China’s economy, it objectively requires a powerful currency with high degree
of internationalization to match with, which is an indispensable rule on the development of economy
and finance. Therefore, it is well aware that the internationalization of RMB is a definite result of
economic development in China. The outbreak of US financial crisis has quicken the urgency of
reestablishment of international currency system, and granted a valuable historical opportunities for
internationalization of RMB. While, it should be noted to strengthen the perfection of finance market,
value the control of financial crisis, and reduce the cost to the lowest in the process of
internationalization of RMB.
＊GG-LL: Please note that GG and LL are the general names given by the famous economist Krugman
to describe his model, just like the marks of the two curves. They don’t stand for specific meaning and
are not the abbreviations of anything either.
References
[1]. Qian Rongkun. International Finance. Tianjin: Nankai University Press2003:3-18(in Chinese)
[2]. Chen Yulu. International Finance & Banking. Beijing: People’s University of China Press,
2008:136-148(in Chinese)
[3]. Michael Melvin. International Currency & Finance. Shanghai: Shanghai People’s Press.
1994:96-102(in Chinese)
[4]. Wang Yuanlong. Strategies & Process on the Convertibility in Capital Account and
Internationalization. China Finance 2008(10).36-39
[5]. http://www.safe.gov.cn/model_safe/index.html
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