The renminbi’s global reserve and financial role remains a hot topic of conversation. Some argue that the currency is maturing and that a digital renminbi will propel it forward. Others, including myself, believe that the global role of the renminbi will remain fairly modest for the foreseeable future. While Chinese authorities may find it beneficial to depreciate the dollar and the role of the United States in the international monetary system, a major global role for the renminbi is not in China’s interest.
It’s all about control. The Chinese authorities want to maintain strict control over the economic and financial system, mainly to guard against potential instability. This only complements the trend of increased political control over Chinese society under President Xi Jinping.
The dollar’s overall status reflects the size and openness of the US economy, good legal protections for investors, and the depth, strength and liquidity of US financial markets. The United States has an open capital account. This is in stark contrast to China and its interests.
The dollar floats in the forex markets and can fluctuate considerably from time to time. Its global role attracts capital. One implication is that the dollar is often viewed as overvalued. In contrast, the renminbi is managed with a view to maintaining the general stability of the currency. It is not convertible. The authorities are not ready to let the renminbi float.
The United States has continued current account deficits. China has traditionally recorded large current account surpluses. Although these have fallen sharply relative to gross domestic product over the past decade, China’s merchandise trade surplus remains large. China’s export sector remains an important engine of growth and a key pillar of the economic model. Although much is said about this model of transition to domestic services and consumption, recent trends in savings and investment suggest that the transition is taking place slowly.
China’s aversion to free float concerns not only the current account, but especially the tightly controlled capital account. The United States is generally comfortable with fluctuations in capital flows, absorbed by its deep capital markets. China is not. Despite the controls, large capital inflows and outflows can strain China’s ability to manage the renminbi.
For example, between mid-2010 and early 2014, the renminbi appreciated against the dollar, even in the face of heavy official purchases of Chinese dollars, with market participants viewing the appreciation of the renminbi / dollar as a one way bet. But until early 2017, the Chinese currency fell sharply after authorities made it clear that the appreciation of the renminbi could no longer be seen as such. The selling pressure was so intense that the People’s Bank of China sold about $ 1 billion to avoid further depreciation.
More recently, as renminbi assets have been included in global bond and equity indices and favorable Chinese government bond yields have attracted inflows, the authorities’ strategy has sought to allow a capital account to be opened, by balancing inputs and outputs. They know, however, that this can be a risky strategy. Chinese wallets are concentrated at the national level, but many citizens want to internationalize them. Errors and omissions in the balance of payments data suggest that there may be a strong desire among Chinese residents to take out money.
Lobbying for global financing and a reserve role for the renminbi could perhaps be a useful strategy to encourage reform of domestic financial markets. This strategy was deployed by the former PBoC governor, Zhou Xiaochuan. But caution is required in letting steps towards internationalization such as capital account liberalization precede national reforms, a point that Zhou and his team have understood. A bad balance could potentially trigger instability.
Economists agree that to reap the benefits of capital account liberalization, it must be accompanied by financial sector reform. Without a strong banking system, large capital outflows and their consequences on exchange rates can lead to costly imbalances in national balance sheets. China’s financial and non-financial business system is renminbi-driven, so it’s not really a problem at the moment. But its banking system remains weak, non-performing loans are woefully underreported and masked by constant renewal, and its capital markets are underdeveloped. This too will weigh on the minds of the authorities, especially since they are grappling with excessive leverage on the Chinese economy.
Xi steadfastly pursued a state policy, reaffirming the party’s control over economic life. Recent official actions regarding technology provider Ant Group, transport company DiDi and other fintech companies show that authorities are determined to maintain tight control over financial markets and information flows. Chinese control over Hong Kong will undermine Hong Kong’s role as a beacon of financial openness. Together, these factors will also dampen the enthusiasm of global investors for the renminbi.
The Chinese authorities have significantly stepped up their far-reaching efforts to control the financial system and innovation. It is not in China’s interest to pursue global financing and a reserve role for the renminbi until it makes major strides in strengthening its financial system, overhauling its trading model. growth and relinquishing control to allow a more invisible hand to flourish. The authorities know this.
Mark Sobel is the US President of OMFIF.
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