Breakthroughs in RMB internationalization

Financial institutions and markets across the world are increasingly using the Chinese currency

Internationalization of the renminbi, the Chinese currency, has progressed steadily and may enter a new stage after its inclusion in the International Monetary Fund's special drawing rights basket.

By the end of last year, the RMB internationalization index, a comprehensive quantitative indicator of international acceptability, reached 3.6, up 42.9 percent year-on-year and a rise of more than 10 times from five years ago.

Renmin University of China's International Monetary Institute founded the RII to meet the cognitive needs of the international community on RMB internationalization and objectively reflect the use of the currency in international economic activity.

The index ranges from 0 to 100, and the recent rise indicates that the RMB is undertaking more of the functions of an international currency.

In the past few years, RMB internationalization has maintained momentum despite international financial market adjustments, domestic financial market turbulence and exchange market panic. After the US Federal Reserve raised interest rates, the US dollar index rose continuously, dollar-denominated assets were targeted and international capital flow experienced profound adjustments. These factors have gravely exacerbated the pressures caused by capital outflow in China.

Moreover, high levels of leverage and margin trading led to the stock market crash in the first half of last year, resulting in the evaporation of more than 20 trillion yuan ($2.9 trillion; 2.6 trillion euros) in share values. In the second half, offshore RMB liquidity contracted acutely as market panic sparked exchange rate overshooting.

Despite this temporary turbulence, RMB internationalization has progressed steadily and may enter a new stage after inclusion in the SDR basket.

More specifically, last year, the RII was 2.48 in the first quarter, with a year-on-year growth of 7.8 percent, 2.76 in the second quarter (16.9 percent growth), 3.87 in the third quarter (84.3 percent growth) and 3.60 in the fourth quarter (42.9 percent growth).

The RII maintained average growth of 38 percent per quarter but moderated in the fourth quarter after reaching a historically high value in the third quarter, as market panic resulted in the exchange rate overshooting on Aug 11 and offshore RMB liquidity contracting acutely.

In the face of the complicated domestic and international economic environment, the internationalization of the RMB continues to quicken and the international use of the currency presents a rapid growth trend.

The quick rise of RII is a result of the following reasons.

First, China's economy maintained a steady performance, and financial reform advanced in an orderly manner. Last year, despite mounting downward pressure, the Chinese economy was still the most stable in the world, laying a solid foundation for RMB internationalization.

As an emerging markets flagship, China saw GDP grow by 6.9 percent last year, a world-leading rise. The government has continued with supply-side reform and maintained a prudent monetary policy, while the financial system showed its resistance in risk-prevention efforts.

These factors provided a continuing driving force for RMB internationalization. China's current account surplus reached $293.2 billion, up 33.5 percent year-on-year, and outward direct investment registered 14.7 percent growth year-on-year.

The country has maintained a balance of international payments, and cross-border capital outflow has returned to a level consistent with economic fundamentals.

Last year represented a critical period in terms of financial reform; the cap on deposit rates for commercial banks and rural cooperative financial institutions was removed, and interest rate controls were basically removed. The formation mechanism for the RMB central parity rate was improved, and the exchange rate regime was further liberalized.

The market rate and offshore rate in reference to the central parity rate and onshore rate were effectively adjusted.

An RMB exchange rate index in reference to the China Foreign Exchange Trade System basket of currencies was introduced, the People's Bank of China's management of the foreign exchange market was improved and overseas bids to short the RMB were resisted.

All these efforts helped to lead market expectations back to a reasonable level. The country launched pilot programs to facilitate innovation and then introduced successful practices across the country, gradually promoting RMB convertibility under the current account.

Second, policies on cross-border RMB businesses under the capital account were improved. Despite the exacerbated fluctuations in domestic and foreign financial markets, and the mounting pressure of capital outflow, China still made breakthroughs in improving policies on cross-border RMB use, which helped to expand RMB backflow channels, optimize the allocation of business funds and boost the development of the real economy.

The controls on companies' abilities to issue bonds in overseas markets and on bilateral cross border RMB cash pooling were further relaxed to allow enterprises more independence and offer them more assistance in overseas fundraising.

Central banks overseas and other official reserve management entities, international financial organizations and sovereign wealth funds were allowed to participate in China's interbank foreign exchange market in accordance with the relevant laws and regulations. These institutions can undertake foreign exchange transactions including spots, forwards, swaps and options.

By opening the interbank FX market, China tried to make the RMB more representative and improve its function as an international reserve currency. The Shenzhen Qualified Domestic Investment Enterprise pilot program was officially launched and the Shanghai-Hong Kong stock connect operated smoothly. That led to asset allocation in China becoming more diversified.

Third, the RMB infrastructure was improved and supporting mechanisms were aligned with international standards. China's financial infrastructure and supporting mechanisms were also improved, offering both physical and institutional support for internationalization of the currency. Moreover, clearing banks were established and their layout was optimized, forming an international network of RMB clearing and ensuring sufficient liquidity in offshore RMB markets.

In October, China launched the first phase of the RMB Cross-border Interbank Payment System, which offered clearing and settlement services to domestic and foreign financial institutions in their cross-border and offshore RMB businesses. The system covered all major financial centers, with the exception of the US, and represented a major step forward in the development of an RMB payment system.

Meanwhile, the country vigorously introduced international standards of data collection and dissemination, adopted the IMF's special data dissemination standard and participated in the Bank of International Settlement's international banking statistics and a survey of the currency composition of official foreign exchange reserves.

Fourth, as the Belt and Road Initiative progresses steadily, Sino-European economic and financial cooperation is experiencing a burgeoning wave. Since the initiative was launched, China has signed agreements and memorandums of understanding with 31 countries and regions, and many key projects have been implemented. All these have helped deepen regional economic and trade exchanges.

The Asian Infrastructure Investment Bank has started operation, offering a solid platform for capital market connectivity through the RMB in areas along the Belt and Road routes.

Last year, the China-Australia and China-South Korea free trade agreements were officially implemented. China has signed agreements on production capacity cooperation with more than 10 countries, and currency swap agreements with Suriname, Armenia, South Africa, Chile and Tajikistan.

China has also accelerated the development of free trade zones and financial pilot zones, further enhancing the RMB's status in international payment, settlement, investment and fundraising.

Sino-European financial cooperation has taken a great step forward and this is especially worth noting. The European Union has become China's largest trading partner, the largest source of imported technology importation and a key investment partner. Last year, Sino-European business cooperation amounted to more than $169 billion.

The leaders of China and many European countries have maintained frequent exchanges, visits and dialogues on the economy and finance. These factors have further boosted the offshore RMB markets in Europe and deepened bilateral cooperation in terms of market access, cross-border supervision, investment platforms and support facilities.

Finally, against the backdrop of financial turbulence and a strong dollar, RMB denomination has risen in commodity trades. Although the international price of oil remained low and the petrodollar continued to contract, RMB usage actually rose in the Middle East.

Last year, the Qatar RMB Centre was established, and China signed a memorandum of understanding with the central bank of United Arab Emirates. Therefore, the RMB became the currency of choice in UAE and Qatari payments to the Chinese mainland and Hong Kong.

The UAE's use of the RMB accounted for 74 percent of payments by value to the mainland and Hong Kong, a rise of 52 percent compared with 2014. In Qatar, the RMB was used for 60 percent of such payments, a rise of 247 percent compared with 2014.

Serbia has initiated RMB settlement programs. In Russia, the currency is increasingly accepted and has become the most welcomed currency after the dollar and the euro. The Moscow Exchange has also launched RMB-rouble futures trading, and the London Metals Exchange accepts the RMB as collateral.

In July, an international market for commodities' spot trading was launched at the China (Shanghai) Pilot Free Trade Zone. As a result, RMB-denominated commodities took a substantially enhanced position in global trading.

This piece was authored by the research team at Renmin University of China's International Monetary Institute. The views expressed do not necessarily reflect those of China Daily.