HKUST Business School Magazine

Biz@HKUST Biz@HKUST 40 41 // Cover // Insight Through this strategy, China sets up a firewall between the onshore and offshore markets, allowing full convertibility of the RMB in the offshore market but partial convertibility in the onshore market. Behind this approach are a number of policy measures, including financial market liberalization, capital account opening, and the facilitation of the formation of a number of offshore RMB centers, such as Hong Kong, Singapore, and London. Based on theory and evidence, I conclude that China’s economic size, its commitment to sufficiently free capital mobility, the development of a deep, broad and liquid financial market, and people’s confidence in the RMB are the four key factors for the success of RMB internationalization. China has economic size, but it needs to work on the other three factors. It is not at all clear whether and when China would achieve the sufficient degrees of capital mobility and financial market development to make the RMB a significant international currency on a par with say the euro, not to mention the USD. Moreover, it seems difficult for a country without a mature legal system and a system of checks and balances to secure the confidence of the world on its currency. Thus, my conjecture is that, in the intermediate term, the RMB would only be a distant third payment currency (behind the USD and the euro). In the longer run, because of China’s large GDP and continuing reforms and opening, and the world’s central banks’ demand for safe assets for foreign exchange reserves, the world may become a multi-reserve-currency system, with the USD, Euro and RMB being the three main reserve currencies. However, the road for the RMB to get there may be quite long and uncertain. Positive feedback Based on econometric analysis, I find that financial development and capital account opening are much more important than the GDP of China in making the RMB an international currency. My model predicts that it is possible that, by 2030, the RMB can rank a distant third (behind the USD and the euro) in the global ranking of currencies used in international payments, surpassing the British pound sterling. I estimate that RMB’s payment share can reach 6.6% by 2030 (it is about 1.5% to 2.0% today, compared with about 55% for the USD and about 20% for the euro 1 ). However, this is possible only if China greatly speeds up its financial development and capital account opening in the next decade. I also argue that there is a positive feedback effect (or synergy) between capital account liberalization and domestic financial sector reform. This argument provides the rationale for using the internationalization of RMB to force domestic financial sector reform. This is called “daobi” ( 倒逼 ) in Chinese, which I believe is (silently) advocated by some quarters in the Chinese government. I argue that “daobi” is one important motivation of internationalizing the RMB. For this reason, the sequence of liberalization in China should not strictly follow that of conventional wisdom, namely financial market liberalization should take place before capital account liberalization. Instead, the two liberalization initiatives should proceed interactively in tandem. By 2030, the RMB can rank a distant third [behind the USD and the euro] in the global ranking of currencies used in international payments, surpassing the British pound sterling 1. Intra-eurozone payments and payments to/from global market infrastructure are excluded.