Popular discussions about the prospects of China's currency, the renminbi, range from the view that it is on the threshold of becoming the dominant global reserve currency to the concern that rapid capital account opening poses serious risks for China. A number of recent academic studies have pointed to the renminbi's rising importance in the international monetary system, although these studies are divided on the renminbi's prospects of becoming a dominant global reserve currency (see Eichengreen 2011a, Subramanian 2011, Frankel 2012, and Yu 2012).
This issue has broader ramifications, as the rise of China's economy and its currency has implications for global macroeconomic and financial stability. Among the currencies of the world's five largest economies, China's renminbi is the only one that is not a reserve currency. Even though the economy has neither a flexible exchange rate nor an open capital account, the Chinese government has recently taken a number of steps to increase the international use of the renminbi. Given China's rising shares of global GDP and trade, these steps are gaining traction and portend a rising role for the renminbi in global trade and finance.
The popular debate often conflates three related but distinct aspects of the renminbi's role in the global monetary system: (1) internationalization--its use in denominating mad settling cross-border trade and financial transactions (i.e., its use as an international medium of exchange); (2) capital account convertibility--the country's level of restrictions on inflows and outflows of financial capital. A fully open capital account has no restrictions; and (3) reserve currency whether the renminbi is held by foreign central banks as protection against balance of payments crises.
A currency's international usage and its convertibility are different concepts, and neither one is a necessary or sufficient condition for the other. Both conditions have to be met, however, for a currency to become a reserve currency. In this article, we consider these aspects in turn.
Internationalization of the Renminbi
China is promoting the international use of its currency by:
* Permitting the settlement of trade transactions with the renminbi
* Easing restrictions on cross-border remittances of the renminbi for settlement
* Allowing the issuance of renminbi-denominated bonds ("dim-sum" bonds) in Hong Kong mad by foreigners in the Mainland
* Permitting selected banks to offer offshore renminbi deposit accounts
* Setting up local currency bilateral swap lines with other central banks
The trajectory is steep in each of these categories but the amounts are still modest. Trade settlement occurs mostly on the import side; dim-sum bonds remain narrow in scope in terms of industry (primarily banking and financial institutions) and geography of issuance (primarily mainland China); and bilateral swap lines are not always drawn upon. Nevertheless, a big advantage for China is that Hong Kong provides an effective platform for launching these measures in an experimental manner without full capital account opening. However, these developments could soon hit their limits unless China's capital account becomes more open.
The renminbi is 'also starting to appear in the reserve portfolios of some emerging market as well as advanced-economy central banks. The bilateral currency pact that China and...