Wendy Guo, CFA, recently sat down with Tse Yung Hoi to discuss the basic concepts, background, and key milestones of renminbi (RMB) internationalization, as well as lessons to be learned from the internationalization of the Japanese yen. The following is an English translation of that interview, which was originally conducted in Mandarin Chinese on 15 September 2011.
Wendy Guo: Let’s begin by speaking about the origin and basic concept of the internationalization of the renminbi. A few decades ago, the Japanese yen also underwent a process of internationalization. What lessons can we draw from that?
Tse Yung Hoi: The internationalization of the renminbi, to first give it a definition, means taking the renminbi outside of China and allowing nonresidents to hold the renminbi extensively overseas and use it as a currency for routine payments, settlements, investments, and reserves. This is how we define the internationalization of the renminbi.
So, there is an international call for more currencies to be involved in the international monetary system, and the renminbi is viewed positively by all for this purpose. That is to say, the intrinsic reason lies in the rapid development of China’s economy over the past 30 years. Today, the Chinese economy is still developing with great momentum, with its GDP reaching 5.8 trillion U.S. dollars last year and becoming the second largest economy worldwide. Meanwhile, China has the largest foreign exchange reserves and the second largest trade volume in the world. China’s domestic deposits amount to 78 trillion renminbi, which is 200% of the GDP of Hong Kong. No other country has deposits and reserves on such a scale.
Therefore, in a certain sense, China’s GDP and foreign trade now both account for around 9% of the global total, and from this phenomenon, from the sheer size, some of the preconditions for internationalization are already in place. However, for true internationalization of the renminbi, the preconditions are free convertibility, market-oriented interest rates, and open capital markets. But these preconditions have not yet become reality. In such circumstances, we have to look at the offshore market for the renminbi, which means that the domestic and overseas renminbi [markets] are separated. For this reason, Hong Kong is shaping up to potentially becoming an offshore center of the renminbi.
But then, what happened during the process of internationalization of the Japanese yen? I believe that in 1985, after the Japanese economy had undergone a period of rapid growth, Western [countries] forced Japan into signing the Plaza Accord. At that time, Japan seemed to be rather arrogant as it believed it was leading the world in economic trends, and so on. Therefore, Japan relaxed some subsidy [policies], and at that time, maybe there weren’t any lessons in this regard, so Japan accepted the Plaza Accord. After the Plaza Accord [was signed], three events happened in Japan. First, the exchange rate [of the Japanese yen] rose rapidly — by 80% within three years. Second, Japan allowed foreign investment banks and securities firms to establish branches in Japan, with the aim of making Tokyo an international financial center. Third, after the Plaza Accord [was signed], the Japanese yen that flowed overseas during the yen’s process of internationalization flowed back into Japan because of the yen’s appreciation along with the bubbles in real estate prices and the stock market. Such a rapid backflow made the bubbles even bigger. Because of these three events, the Japanese economy has basically remained sluggish in the past 20 years since the bubbles broke.
Therefore, personally, I think we can draw the following lessons from the successes and failures in the internationalization of the Japanese yen. First, the internationalization of a currency should depend on [a country's] inherent rate of economic development rather than external pressures.
Second, [China] needs to develop independently and develop the exchange rate and internationalization of the renminbi step by step according to its own needs. Moreover, [China] needs to establish a sound mechanism for [currency] backflows. Japan had a loophole in the backflow mechanism of the yen, and I am not going to elaborate too much in technical terms here. A lot of offshore yen flowed through this loophole back into Japan. This is the second point. Third, during the process of its internationalization, the yen appreciated too quickly, which made the bubbles even worse later. I think we need to pay close attention to these areas.
During the internationalization of the renminbi, we must first proceed independently at our own speed and promote renminbi internationalization step by step. Second, we shouldn’t allow rapid [renminbi] appreciation tomorrow just because Western [countries] demand this today. We should [act] according to [the development of] our own economy.
So, as a third point, we must establish a good [currency] backflow mechanism. The fourth point is how to develop Hong Kong into a well-rounded offshore center for renminbi receipts, payments, settlements, investments, and reserves when [China's] capital markets are still not open. As an offshore center of the renminbi, Hong Kong acts as a firewall for renminbi inside China and also as a trial entity in our promotion of the internationalization of the renminbi.
As of this time, how much progress has been made in the internationalization of the renminbi? Which important milestones have we passed?
Actual research on internationalization of the renminbi had already started more than 10 years ago. There were people who had already proposed this topic of study [by then]. But in terms of actual implementation, [the research] was actually started in 2004. Before 2004, the renminbi was basically circulating outside of China without regulation. In 2004, banks [in Hong Kong] began to accept renminbi deposits, allowing exchanges and remittances in small amounts. This began in 2004. The first stage is basically the retail business stage of the renminbi.
The second stage actually [started] in 2007, when the Chinese government began allowing financial institutions to issue renminbi bonds in Hong Kong. This is a major step up for the renminbi, moving it from the retail level to the capital investment level. With the development of the bond [market], renminbi deposits in Hong Kong increased.
The third stage probably started in 2009, when 365 enterprises in five Chinese cities started cross-border renminbi trade settlements with [partners in] Hong Kong, Macau, Taiwan, and ASEAN countries on a trial basis. This has further increased the quantity of renminbi overseas.
In July last year , the People’s Bank [of China] signed a new settlement agreement with the Hong Kong Monetary Authority permitting free flows of the renminbi between individual and enterprise accounts. This helped to invigorate the whole market. Meanwhile, the central [Chinese] government also clarified Hong Kong’s position as an offshore center of the renminbi. So, from then on, there have been substantive changes in the whole renminbi market in Hong Kong.
For instance, renminbi bonds began to be issued [in Hong Kong] in 2007–10 billion for 2007, 12 billion for 2008, 14 billion for 2009, but more than 30 billion in the second half of 2010. In the first half of this year , 70 [billion renminbi] in bonds have been issued. From the perspective of bond issuance, there are substantial changes.
Second, with cross-border trades starting in 2009, the total value has increased from 10 billion, 20 billion to 30 billion renminbi, and up to 200 billion renminbi in June this year alone, so the total value of cross-border trades this year is expected to exceed 800 billion renminbi. In the first half of the year, deposits multiplied several times over. At the beginning of last year, Hong Kong had only 64 billion renminbi in deposits. At the end of last year, it had 370 billion renminbi. In June this year, it had 570 billion renminbi. There is momentum for rapid development.
There are more data than that. There have also been rapid developments in renminbi-denominated products since the second half of last year. For instance, commercial bank deposits, remittances, exchanges, trade settlements, trade financing, interbank borrowing, bonds, renminbi insurance, and funds, including the second renminbi-denominated stock issuance this year, called “REIT.” The emergence of all these products has increased [the trading volume] of the renminbi in Hong Kong for more than just payments, settlements, and investments.
There have also been major changes in investment tools and market operating modes. For instance, foreign exchange transactions in renminbi-including spot transactions, forward transactions, currency repos, and bond indexes, and also the bond yield curve-have all appeared. The HIBOR [Hong Kong Interbank Offered Rates] on interbank borrowing in renminbi has also emerged. With these tools, I believe other derivative products and hedging tools will emerge and gradually mature in the future. So, I feel that until now, the fledging [offshore] renminbi market has gradually been coming into being by going through several stages of development.
What is the most critical issue now?
As a matter of fact, the most critical issue is the further development of offshore centers of the renminbi, and I feel this is still very important to the internationalization of the renminbi. In the short term, I don’t expect the full opening of China’s capital markets and fully liberalized conversion of the renminbi. In such circumstances, during the internationalization of the renminbi, offshore centers will still play important roles. For the next step, the most important issue, in my opinion, is how to [further] popularize the renminbi outside of China. This is because right now, China is different from the U.S. The U.S. has fiscal and trade deficits, right? China has limited fiscal deficits, a trade surplus, and a capital surplus. So, we need to [further] popularize the renminbi overseas, and plenty of efforts have to be made. Internationalization is impossible if the renminbi is [not accepted in international markets]. So, we must think of ways to popularize the renminbi abroad; this is a very critical point.
So, how to [popularize] the renminbi abroad? China has taken the following measures so far: First, encouraging the use of the renminbi in cross-border trade. China shares borders with 14 neighboring countries, and there is cross-border trade at each border. Right now, as far as I know, 80% of the volume of these cross-border trades is settled in renminbi because most people are willing to use renminbi. This is the first point.
Second, we have signed a free-trade agreement with ASEAN. According to this agreement, 95% of trade between China and 10 ASEAN member countries is tariff free, so trade volumes are on the rise in both directions. In addition, many ASEAN countries accept renminbi as the trading currency for transactions with China. They are using renminbi for settlement more and more frequently.
Third, we have signed currency swap agreements with 12 countries, meaning that China can swap renminbi with the currencies of those countries so that we can purchase their resources and products using their currencies and they can buy our products with renminbi or use renminbi as part of their foreign exchange reserves. Some countries have included the renminbi as part of their foreign exchange reserves, and this is also one [turning point] in the internationalization of the renminbi.
Furthermore, early this year, the first document [was issued by] the People’s Bank [of China] that specifically addresses overseas direct investments in renminbi: the detailed rules about overseas direct investments, which encourage domestic enterprises to invest overseas with renminbi. As far as I know, there have been many cases like this [where the renminbi is used for overseas investments]. Moreover, some international [organizations] . . . , such as the IMF and the Asian Development Bank, also come to China to [issue] renminbi bonds, to borrow renminbi to use in some of their special projects. Generally speaking, we are continuing to promote [the internationalization of the renminbi].
Also, in a certain sense, maintaining the stable appreciation of the renminbi right now is also important to establishing a sort of credibility of the renminbi. This is very important too because it helps to gradually establish the credibility of the renminbi for everyone. To move [the internationalization of] the renminbi forward, we have to consider several factors. First, [China's] comprehensive economic strength has to be large enough. Second, [China] must establish the credibility of the renminbi. Third, we must foster the comparative advantages of the Chinese economy over Europe, the U.S., and Japan. I believe China is making efforts right now to achieve these goals. Fundamentally, of course, the internationalization of the renminbi is not aimed only at internationalization of the renminbi; [China] must improve its overall economic strength, maintain rapid economic development, and settle its own problems. This is a major theme for internationalization of the renminbi, I think.
Mr. Tse, thank you for sharing with us your views on the internationalization of the renminbi. Thank you very much!
The second part of this interview discusses the RMB Qualified Foreign Institutional Investor (QFII) and RMB Foreign Direct Investment (FDI) schemes and the role that the RMB will play in the global monetary system over the next 5 to 10 years.