THE SLOW, UNEVEN RISE OF THE RENMINBI.

• Author: Prasad, Eswar S.

The Chinese renminbi (RMB) has come a long way in a short period. It was only in die early 2000s that die Chinese government began the process of gradually opening up the country's capital account, allowing financial capital to flow more freely across its borders. This process was very gradual at first and picked up pace only a decade later. Over the last few years, the RMB's progress as an international currency has been remarkable in some aspects. However, the currency's seemingly inexorable progress stalled in 2014. Starting in mid-2014, the Chinese economy seemed to be losing steam, domestic and foreign investors became less confident about die stability of its financial markets, and, to compound these problems, China's central bank made some missteps as it attempted to make the currency's value more market determined.

Nevertheless, in October 2016, the RMB achieved a major milestone in its ascendance as an international currency. That month, the International Monetary Fund (IMF) officially anointed the RMB as an elite global reserve currency. The RMB joined the select basket of currencies (previously comprising the dollar, the euro, the Japanese yen, and the British pound sterling) that constitute the IMF's artificial currency unit, the special drawing right (SDR). However, this does not by itself mean that the RMB is already in a position to significantly reshape global finance, and it still has a long way to go before it can play a major role in international finance.

This article considers three related but distinct aspects of the role of the RMB in the global monetary system and describes the Chinese government's actions in each of these areas. First, I discuss changes in the openness of China's capital account and the degree of progress toward capital account convertibility. Second, I consider the currency's internationalization, which involves its use in denominating and settling cross-border trades and financial transactions--that is, its use as an international medium of exchange. Third, I trace the RMB's evolution as a reserve currency.

The RMB is likely to become a significant player in international financial markets even if its rise to prominence levels off, yet its full potential may remain unrealized unless the Chinese government undertakes a broad range of economic and financial system reforms. In the long run, what the RMB's ascendance means for the global financial system depends, to a large extent, on how China's economy itself changes in the process of elevating its currency.

Capital Account Opening

In recent years, the Chinese government has taken a number of steps to elevate the RMB into this group of elite currencies by increasing its international use. However, the RMB's adoption in global markets has been limited by the Chinese government's unwillingness to free up its exchange rate and fully open the capital account. (1)

The government has removed restrictions on capital inflows and outflows, but in a controlled and gradual manner. For instance, the government has set up a number of schemes to allow foreign investors to invest in China's stock and bond markets. These include the Qualified Foreign Institutional Investor Scheme and the Renminbi Qualified Foreign Institutional Investor Scheme.

At the same time, there are now many channels available for Chinese households, corporations, and institutional investors that wish to invest some portion of their investments in foreign markets. This includes the Qualified Domestic Institutional Investor and Qualified Domestic Individual Investor Schemes.

A few channels for two-way flows, such as the Stock Connect and Bond Connect programs, have also been opened up. But the government continues to maintain a tight grip over each of these channels.

China continues to manage its nominal exchange rate, although it has in principle allowed market forces to play an increasing role in determining the external...