The means not the end

Renminbi's internationalization should be instrument for the rapid growth of its foreign trade and investment and financial sector, not a goal in itself

In recent years, the renminbi's internationalization has been continuously advancing. The renminbi's global payment share reached 2.3 percent in 2022, making it the fifth largest payment currency in the world. As of the end of last year, the renminbi's share in global foreign exchange reserves stood at 2.7 percent, also the fifth largest. In May 2022, the International Monetary Fund increased the weight of the renminbi in its Special Drawing Rights currency basket from 10.92 percent to 12.28 percent, giving the Chinese currency the third biggest share of the SDR basket.

At present, there are favorable conditions for China to further internationalize the renminbi.

The profitability and security of the Chinese currency has lured many countries to allocate more renminbi assets. In 2022, the 10-year treasury yield of the renminbi basically exceeded 3 percent, higher than that of treasury bond of developed countries such as the United States. The status of the renminbi in some countries' reserve assets is also rising. The Brazilian central bank announced in March that the renminbi now accounts for the second-biggest share of Brazil's international exchange reserves. In July 2022, the central bank of Belarus included the Chinese currency in its basket of foreign currencies, with a weight equivalent to the euro.

As China's engagement in regional economic and trade cooperation develops, the renminbi's internationalization within the regions encompassed by the Belt and Road Initiative and the Regional Comprehensive Economic Partnership has been promoted. In 2021, the cross-border renminbi payments between China and countries involved in the Belt and Road Initiative reached 5.42 trillion yuan ($765.17 billion), accounting for 14.8 percent of the total cross-border use of the renminbi in the same period. By the end of 2021, China had signed bilateral currency swap agreements with 22 Belt and Road countries and established renminbi clearing arrangements in eight countries involved in the initiative.

The rise of China's comprehensive economic strength and the rapid growth of its foreign trade and investment and financing will further internationalize the renminbi. However, at present, due to the strong position of the US dollar, the immaturity of domestic financial markets and the renminbi offshore market, the insufficient renminbi payment and pricing functions, as well as the complex international environment, the further internationalization of the Chinese currency faces some challenges.

First, path dependence makes it difficult to shake the US dollar's position. At present, the dollar has an absolute dominance in global foreign exchange reserves, cross-border settlement and pricing, while the renminbi is much more disadvantaged. At the end of 2022, the share of the Chinese currency in global foreign exchange reserves was much lower than its weight in the IMF's SDR basket. Although significant progress has been made in the renminbi pricing and settlement of bulk commodities, the pricing power of the renminbi is still relatively weak. The share of the renminbi in global payments is not yet commensurate with China's position in global trade. In 2022, China's total import and export value exceeded 42 trillion yuan, accounting for nearly 20 percent of the global trade volume, far higher than the proportion of the renminbi used in global payment (2.3 percent). These indicators reflect that there is still a significant gap between the Chinese currency and traditional international currencies such as the US dollar.

Second, the financial infrastructure and institutional arrangements needed for the renminbi's internationalization are not sound yet. As of the end of 2022, more than 1,300 domestic and foreign institutions have directly or indirectly joined the Renminbi Cross-border Interbank Payment System, or CIPS, while the Society for Worldwide Interbank Financial Telecommunication system covers more than 200 countries and regions, providing services to over 11,000 financial institutions. In addition, the renminbi currency swap agreement is not actively used, and the actual usage accounts for only about 10 percent of the renminbi currency swap agreement.

Third, China's financial market is not mature or open enough. Its stock market and stock derivatives market are still underdeveloped, with limited varieties of bond products and frequent bond default incidents. The openness of the financial market is also relatively low. Moreover, the renminbi's internationalization will be accompanied by larger and more frequent short-term capital flows, resulting in more complex forms of financial risks, which puts higher demands on China's financial regulation.

Fourth, due to the incomplete opening of the renminbi capital account, the supply of offshore renminbi is mainly through foreign trade. However, China's large trade surplus makes it difficult for the renminbi supply to meet the demand of the offshore market. What's more, offshore renminbi financial products are not abundant.

Fifth, the rise of international unilateralism and trade protectionism, especially the suppression efforts of the US and some other Western countries targeting China and their "decoupling" with China, will, to a certain extent, weaken investors' confidence in China's economy and its currency.

The further development of the renminbi's internationalization depends on whether China can maintain sustained economic growth, whether it has developed domestic and offshore financial markets, and whether the financial system can be more sound and in line with international rules.

To advance the renminbi's internationalization, it is necessary to make a good institutional design and offer policy support, encourage market entities to use the renminbi for settlement and valuation in foreign trade and investment, and further improve basic systems such as cross-border investment and financing, and transaction settlement. The renminbi is even less internationalized in the financial sector than in the trade sector, which requires it to further improve its valuation and reserve functions. At the same time, industrial upgrading should be accelerated to enhance Chinese enterprises' status in the supply and industry chains, and thereby promote the renminbi valuation function. Additionally, the renminbi offshore market should be further developed.

Efforts should be made to promote the development and opening-up of the domestic financial market, expand domestic financial market, enrich financial products, explore more investment and financing channels, and improve the liquidity in the financial market. China should launch a financial market operation system that is in line with international rules, gradually open its capital accounts, and steadily and gradually open the foreign exchange market, derivatives market and interbank market.

In the process of the renminbi's internationalization, the linkage between domestic and international markets will grow closer, and the cross-border flows of short-term capital will be more frequent. This requires a sound prudential management framework for cross-border capital flows, improving the ability to detect and analyze cross-border capital flows to give early warnings and respond to short-term capital shocks, and maintain the bottom line of avoiding systemic risks.

The renminbi's internationalization requires both top-level design by the State and market-driven mechanisms and must adhere to the principles of the market and enterprises' independent choices. It can only be used as an instrument, not a goal. China should base its strategic planning on economic development and gradually raise the international status of the renminbi.

The author is an associate researcher with the Institute of World Economics and Politics at the Chinese Academy of Social Sciences. The author contributed this article to China Watch, a think tank powered by China Daily.

Contact the editor at editor@chinawatch.cn.