Pathways to Renminbi Internationalization. Barry Eichengreen March 2014

Transcription

1 Pathways to Renminbi Internationalization Barry Eichengreen March

2 A process on many people s minds Here, but also globally. But also a process with multiple motivations. 2

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4 So what do you see in this inkblot? Renminbi internationalization way of limiting China s dependence on the dollar and to confer on Chinese banks and firms the advantages of doing cross-border business in their own currency. It is a corollary of efforts to rebalance the Chinese economy away from the production of goods to the production of services, including financial services, and of process of developing the country s financial markets. It is a Trojan horse of policy makers committed to moving China to a fully open capital account. A way for an increasingly powerful China to project its financial leverage internationally and in the Asia-Pacific region in particular. I will try to give you a sense of which views hold water in what follows. 4

5 It is important to be clear on what we mean by currency internationalization Economists distinguish 3 functions of an international currency. An international currency serves as a unit of account for crossborder transactions the private sector can use it for invoicing international trade and denominating international bonds and loans; while a government can use it as the numeraire to which the local currency is pegged. It serves as an medium of exchange for international transactions: the private sector can use it for settling import and export transactions, for funding cross-border financial transactions, and as a vehicle for direct foreign investment; while governments can use it as a vehicle for foreign exchange intervention. And it can serve as a store of value for international investors; it can be the currency of denomination for a portion of private investors foreign assets and central banks and governments foreign reserves. 5

6 So how fast is the process moving? 6

7 So how fast is the process moving? The answer is fast. To whit: 7

8 RMB trade settlement is growing Impressive progress here. Though different sources provide different estimates. And some signs of progress slowing in recent years. 8

9 RMB deposits in Hong Kong are growing Something that is continuing apace. 9

10 Renminbi denominated and settled FDI is growing Though perhaps not as dramatically. 10

11 RMB denominated bond issuance offshore and internationally is growing. With a lot of interesting variation by sector and country. 11

12 The implications are far-reaching, obviously, both for China and the world. 12

13 Costs and benefits for China Benefits Convenience value in doing cross border business. Reduced exchange risk. Reduced hedging and transactions costs. Advantages for Chinese financial institutions seeking to branch abroad. Increased demand of foreign official sector for Chinese government bonds. Portfolio diversification and consumption smoothing benefits for households and firms. Deeper and more efficient financial markets. Stronger corporate governance insofar as enterprises are subject to stronger shareholder discipline. Costs Loss of monetary autonomy with opening the capital account. Large cross border capital flows, with potential for credit booms. Scope for additional leverage and risk taking by banks. Above all, crisis risk. 13

14 Costs and benefits for the rest of us Benefits Lower costs of transacting with China. Additional scope for diversifying risks. Impetus to global rebalancing. Incentives for other issuers of accepted international currencies to follow sustainable policies. New sources of global liquidity. Costs More exposure to economic and financial shocks from China. Uncertainty about availability of RMB liquidity. Potential instability of a system with multiple international and reserve currencies. Above all, crisis risk. 14

15 So we see that China is part way down the road toward fully internationalizing its currency, with a considerable distance yet to travel. Bringing us to the question: how to best get from here to there? 15

16 This is a process that admits of multiple possible approaches The first pathway prioritizes domestic financial development, liberalization and reform. Domestic reform must come first. Only when that process of domestic reform is well advanced or, in the limit, complete can currency internationalization feasibly follow. Chinese financial markets need to be deepened and developed, while contract enforcement, corporate governance and rule of law need to be strengthened, before renminbi-denominated assets in China will become an attractive unit of account, means of payment and store of value for foreign investors, both private and official. Financial markets need to be substantially reformed by further commercializing the banks, strengthening prudential supervision and regulation, and granting the central bank independence from politics before it will be prudent, from a financial stability standpoint, to adopt the capital account convertibility that is a concomitant of successful currency internationalization. 16

17 The second pathway also acknowledges the necessity, of financial reform but sees renminbi internationalization as a mechanism for accelerating that process. Rapid progress in internationalizing the renminbi will require substantially opening the capital account. Capital account liberalization will require the authorities in turn to accept greater exchange rate flexibility (with an important step in this direction taken earlier this month). It will require interest rate decontrol to bring domestic rates into line with those prevailing in the rest of the world. It will make bank commercialization and strengthened supervision and regulation imperative if China is to cope with a greater volume of capital inflows and outflows. These are of course the same reforms that the country will have to adopt if it follows the first pathway, but in this second approach rapid currency internationalization forces the process. It is an additional source of pressure for the authorities to reform sooner rather than later. It requires them to move faster in deepening, developing and strengthening financial markets. 17

18 The third pathway is an intermediate route in which Chinese financial markets are neither thrown open to the rest of the world as early and completely as in the second approach nor kept closed as long and fully as in the first. One version of this pathway concentrates on selective decontrol of capital flows. Another suggests using offshore financial centers where controls are absent as a platform for launching the process of renminbi internationalization and then progressively deepening the links between those offshore centers and domestic financial markets. A related approach suggests establishing special onshore financial zones, like Shanghai, where the currency can be freely accessed and traded while retaining restrictions between the special zone and the rest of the Chinese economy. Yet another variant of this third pathway focuses on encouraging foreign governments to allow their banks and firms to utilize renminbi credit despite their less than full access to Chinese financial markets by negotiating swap lines between the People s Bank of China and foreign central banks through which renminbi funds can be obtained. 18

19 To be clear on appropriate pathways, one needs to be clear on the endpoint. We ve already defined what an international currency is. But we also have to make a judgment about how many there can be. Is international currency status a natural monopoly? Old view and new view; I m a firm believer in the new view. 19

20 Prerequisites for international currency status Size, stability and liquidity. How does China rate? How does it compare? 20

21 Size: here China clearly qualifies Although a slowdown is clearly coming. (Very much in the news after Monday s <50 PMI reading for the third straight month). My view is that a further slowdown is coming. This is natural. The authorities are reluctant to respond in the traditional fashion with new infrastructure spending or injection of liquidity. A weaker currency that stimulates exports is another option, which they seem to be pursuing. Will this be enough to avoid a hard landing. My view remains yes. But current events are a reminder why RMBI is fraught with difficulty. 21

22 Stability Here there are questions about the stability of the (shadow) financial system. How serious are those problems. Answer is above my pay grade. My view is that if a sharp economic slowdown is avoided, then serious financial problems will be avoided. A big if, of course. 22

23 Liquidity Still only a pale shadow of that in, inter alia, the United States. So progress on this front will be key. What do we know about this process? Deep and liquid markets are not built in a day. It is necessary to proceed on multiple fronts. This means creating a diverse investor base. It means high quality regulation, effective disclosure, efficient clearing and settlement, a ready source of emergency liquidity. 23

24 Especially controversial is the role of capital account liberalization And especially relevant to my topic of pathways. Previous studies of whether it is helpful, neutral or even hurtful for financial development are contradictory. My reading of the evidence is that there are thresholds: capital account liberalization helps only if a country has first achieved a critical threshold in terms of institutional strength, regulation and (indeed) financial development. 24

25 Bringing me finally to the three pathways, which I will now consider in a little more detail 25

26 1) First reform financial markets, then internationalize the currency Meaning specifically: First strengthen and commercialize the banks. Start here because banks dominate the financial system. Extend the regulatory perimeter. Since shadow banking is a growing problem. Develop bond markets. Because these will be especially important for official foreign holders. Only then open the capital account and proceed with currency internationalization. 26

27 And the risks of this approach? Those who benefit from the current system will resist and slow reform. Proceeding so slowly to the destination may mean that momentum is lost. 27

28 2) Use Currency Internationalization to Promote Financial Reform Meaning specifically: Move rapidly in opening the capital account. Larger inflows and outflows will result. This will make it imperative to strengthen the banks, to strengthen policies, and to allow the exchange rate to fluctuate more freely in order to avoid the financial instability that would otherwise occur. The arguments of entrenched stakeholders who oppose reform will be undermined. And the destination will be reached more quickly. 28

29 And the risks of this approach History is littered with the corpses of countries that have opened the capital account prematurely. 29

30 So if the first approach runs the risk of never reaching the destination, while the second runs the risk of being thrown off course by instability, is there an intermediate approach that limits both dangers? You can see that this is where I m headed. 30

31 3) Intermediate approaches to currency internationalization Open the capital account partially and gradually. (OK, but there are questions.) Will take-up of the currency then be enough? There is no previous example of a true international currency of a country with a less than fully open capital account. Might the capital account open spontaneously (arbitrage), creating undesirably high crisis risk? There are also plenty of historical examples along these lines. 31

32 3) Intermediate approaches to currency internationalization Rely on offshore financial centers (as China has done with, inter alia, Hong Kong), and transfer the knowledge and experience gained there back onshore. But who is learning what? Are foreign banks and firms learning about renminbi business and counterparties. Certainly. Are Chinese policy makers learning about the importance of strong rule of law, knowledge that they will then transfer back onshore? Perhaps, but this may be less plausible. And here, too, isn t there significant risk of the capital account opening spontaneously whether the Chinese authorities like it or not? 32

33 3) Intermediate approaches to currency internationalization Rely on onshore special zones (like Shanghai). This approach is consistent with China s feeling the stones approach. But how much leakage will there be between the special accounts for largely deregulated transactions between Shanghai and the rest of the world, and the general accounts between Shanghai and the rest of China? Isn t this potentially a dangerous initiative? 33

34 3) Intermediate approaches to currency internationalization Negotiate RMB swap lines with central banks and other official foreign bodies. This will encourage them to let local banks and firms do RMB business, since they will be in a position to provide emergency RMB liquidity. Useful yes. But reserve holdings tend to be the caboose on the currency internationalization train. So this can only be a small part of the larger process. 34

35 What, then, do I recommend? I recommend proceeding with a variant of the intermediate approach relying on partial capital account liberalization, offshore centers and RMB swaps. I am not so enthusiastic about the STFZ initiative. But, since this is proceeding, it should proceed with due caution. If China succeeds in successfully internationalizing its currency, there will be net benefits for the country itself and for the world as a whole. But there are also significant risks. We should not take success for granted, but rather monitor developments carefully. 35

36 So the process of RMBI is well underway. It will continue. But it may not be as linear, or proceed as rapidly, as many observers, including financial institutions looking forward to RMB business. are inclined to suggest. Much will depend on the pathway followed, where an intermediate pathway promises the best results. Thank you very much. 36