China must gradually hike the yuan's share in international trade settlements and develop it into a key reserve currency

Saturday's decision by the People's Bank of China to reform the renminbi exchange rate formation mechanism has underscored the monetary authority's sense of urgency regarding exchange rate flexibility as well as its determination to adjust the nation's long-held passive position on the matter.

China's rapid economic development and its deepened integration with the global economy over the past three decades have greatly elevated its influence on the world stage.

The country's unwavering efforts to maintain the yuan's stability during the 1997-98 Asian financial crisis, which was in sharp contrast to that of many other nations who rushed to devalue their currencies, garnered for itself the status of a responsible power.

China's reputation and its growing economic influence globally has once again been highlighted by its responsible attitude toward the financial crisis and its well-intentioned moves in its aftermath.

Emerging economies have taken the lead in global economic recovery, with developed countries being left far behind.

Due to their strong domestic demand and declining economic dependence on Western countries, emerging economies like China have enjoyed faster growth than the rest of the world during the past year.

China, India and Brazil achieved 11.9 percent, 8.6 percent and 9 percent economic growth respectively in the first quarter of this year.

According to the International Monetary Fund (IMF), developing nations are expected to see a growth of 7.7 percent in their gross domestic product (GDP) year on year in the first quarter. This is 5.5 percentage points more than that of developed countries.

China's imports have outgrown exports ever since the global financial crisis. This is testimony to the fact that the country's robust domestic demand has already been extended to the rest of the world. As such, this will serve to gradually increase the influence of the yuan and the country's macroeconomic decisions on the world economy.

In its quarterly report on China's economy published on June 17, the World Bank pointed out that the renminbi's nominal effective exchange rate had increased by 14.33 percent by the first quarter since Beijing launched the yuan's exchange rate reform in July 2005, and its real effective exchange rate had increased by 18.28 percent.

During this period, the Chinese currency rose by 21.24 percent and 9.34 percent respectively against the dollar and the euro, and decreased 0.49 percent against the Japanese yen, according to the report.

In particular, China chose to revalue the yuan by a 14.5 percent range in terms of its real effective exchange rate from July 2008 to February 2009, the most difficult period for the world economy.

This indicates the country's attitude as a responsible power, and its desire to maintain global economic stability. Since the global financial crisis, China has taken substantial steps towards developing the renminbi into an international currency in neighboring regions.

Due to its growing influence, some Southeast Asian nations have chosen the yuan as the settlement currency in their trade with China.

In 2009, Shanghai, Guangzhou, Shenzhen, Zhuhai and Dongguan started using on a trial basis the yuan as a settlement currency in cross-border trade with neighboring countries.

By February, China's renminbi-settled cross-border trade volume had grown to 11.6 billion yuan ($146.8 million).

China's central bank has signed currency swap agreements with the monetary authorities of the Republic of Korea (ROK), Malaysia, Indonesia, Belarus, Argentina, Iceland and the Hong Kong Special Administrative Region since December 2008, amounting to 653.5 billion yuan, or 24 percent of its 2.3992 trillion yuan foreign reserves.

At the 2009 finance ministers' meeting between the 10-member Association of Southeast Asian Nations (ASEAN) and China, Japan and the ROK, the three East Asian nations agreed to contribute $96 billion to a planned regional monetary fund, or 80 percent of the total $120 billion. Of that, China promised to contribute $38.4 billion, or 32 percent.

The deepening financial connections indicate that the establishment of a regional monetary alliance in East Asia is imminent.

Currently, Japan is the world's largest capital exporter and China is the largest trade exporter and foreign reserves holder.

The two countries' huge economic and financial strength, together with India's status as a leading service exporter in the world and the abundant labor in ASEAN nations as well as a broad market and yet-to-be-tapped primary resources in Central and Western Asian countries, have laid a solid foundation for closer economic trade within the Asian region itself.

For Asian nations, the establishment of a regional monetary system should take precedence over their efforts to push for global financial reforms.

To set up such a regional monetary system, China, Japan and the ROK must first try to forge a monetary alliance and set up a currency zone in Northeast Asia that is independent of the dollar.

The three neighbors should also try to set up a regional mechanism aimed at strengthening mutual exchange rate coordination and capital flow monitoring, as well as foreign reserves and international payment management.

As China's economic weight continues to rise, concrete measures should be taken to forge the yuan into Asia's leading currency via the regional currency alliance.

The yuan's internationalization is by no means an easy task. Towards this goal, China should gradually increase the yuan's share in international trade settlement, and strive to develop it into the chief investment currency in the international financial market, and finally, into a reserve currency.

The government should create more favorable external conditions for the internationalization of the yuan, such as taking steps to set up channels for the renminbi's overseas investment and financing, and gradually expand the scope of the yuan's pricing, settlement and circulation abroad.

The author is an economics researcher with the State Information Center

(China Daily 06/23/2010 page8)