Journal Article

LONG-TERM AND SHORT-TERM IMPEDIMENTS TO THE RMB'S RISE AS A RESERVE CURRENCY

Dollar, David

2018

Overview

The internationalization of China's currency, the Renminbi (RMB) or yuan, has accelerated since the global financial crisis. On the one hand, the rate at which China is overtaking the United States as the largest economy in the world sped up because of the lingering effects of the crisis on U.S. growth and the fact that China weathered the crisis very well. On the other hand, global and Chinese confidence in the dollar and U.S. financial institutions was seriously undermined by the crisis. China's central bank governor, Zhou Xiaochuan, wrote an article in 2009 criticizing the dependence of the world on the dollar and launching a period in which China actively promoted the internationalization of its currency (Zhou 2009).Initially there was steady and rapid increase in measures of internationalization, such as the RMB's share in global payments (Figure 1). However, the growth came to an end in the middle of 2015, and since then China's share has declined modestly. There was also an expectation that China's growing role as a source of development finance would enhance the importance of the RMB. China in the period 2012-14 lent about $40 billion per year to developing countries for infrastructure projects, including along the Belt and Road, according to updated AidData (Dreher et al. 2017). Curiously, most of this lending is in dollars and only 2.6 percent was denominated in RMB.How do we understand the stalled progress in the emergence of the yuan as a major currency? China's prospects to be the largest economy in the world in about 10 years have not changed. But other factors that are relevant for reserve currency status are coming increasingly into play. Prasad (2015) identifies several factors that are relevant to reserve currency status, in addition to market size: open capital account, flexible exchange rate, macroeconomic policies, and financial market development.In addition, there is a significant literature relating financial market development and macroeconomic policies to underlying institutions such as property rights and rule of law and open political institutions. At the moment, China has institutional weaknesses that hamper its emergence as a major reserve currency country. It also has limitations on capital account openness and exchange rate flexibility that are more in the nature of short-term impediments.The next two sections focus on (1) the institutional weaknesses that are long-term impediments and (2) the current situation with macroeconomic policies, the capital account, and the exchange rate. It is not surprising that the initial enthusiasm over RMB internationalization has waned to some extent: China is a long way from meeting the conditions to be a major reserve currency country.

• Publisher: Cato Institute
• Subject: Analysis / Authoritarianism / Balance of payments / Capital / Central banks / Civil liberties / Developing countries / Development finance / Economic conditions / Economic crisis / Economic development / Economic models / Economic policy / Economic reform / Financial institutions / Financial market / Flexibility / Floating exchange rates / Foreign exchange rates / Foreign exchange reserves / Foreign investment / GDP / Globalization / Gross Domestic Product / Infrastructure / Institutions / International finance / LDCs / Long term / Low income groups / Macroeconomics / Markets / Money / Money demand / Openness / Payments / Per capita / Political institutions / Political systems / Property rights / Prospects / Purchasing power parity / Quality / Renminbi / Renminbi (China) / Reserve currencies / Rule of law / Securities markets / Short term / Standard deviation