Why RMB internationalization is vital
Globalizing the currency will help China safeguard against external financial risks
As an important national strategy, the internationalization of the renminbi is not only a driving force for financial reform going forward, but also part of China’s opening up.
In the process of promoting reform of China’s financial system, it is important to actively and steadily promote the internationalization of the renminbi because this is a matter of national financial security that has a bearing on whether the country can effectively deal with external shocks and avoid related risks. For a long time, China has been highly dependent on the dollar and the international monetary system dominated by the United States.
The intensification of financial sanctions by the US government will affect the role of the dollar as an international reserve currency and international payment currency to a certain extent, weaken the close relationship between the dollar and important public products, and reduce the dependence of many economies on dollar reserves and dollar-based transactions.
From the perspective of reserve currencies, the most important factor is diversification. Therefore, many economies in the world will inevitably begin to consider reserves of other currencies besides the US dollar, including the renminbi.
The increasing internationalization of the renminbi will have a very positive impact on China. When a country’s currency becomes an international currency, the reduction in its transaction costs will make the country’s international capital flow smoother. That is especially the case when the international currency market is in turmoil, and an international currency helps its issuing country avoid speculative capital flows.
In fact, the internationalization of the renminbi and exchange rate marketization reinforce each other.
The marketization of the exchange rate is conducive to giving play to the exchange rate’s role as a safety valve, enhancing the flexibility of the economy to respond to external shocks, increasing the willingness of foreign entities to accept the renminbi, and providing new opportunities for the internationalization of the renminbi.
Enhancing the flexibility of the renminbi’s exchange rate, so that it can effectively cushion against external shocks, and give full play to the role of the exchange rate in adjusting the balance of payments, would help to effectively deal with the challenges of the complexity of Sino-US relations and the prolonged impact of the pandemic.
A floating exchange rate means that when the liquidity of the US dollar changes, the exchange rate of the renminbi should be allowed to automatically respond. The corresponding impacts then need to be responded to in a timely manner with effective adjustments in domestic monetary and interest rate policies.
Although it is undeniable that a floating exchange rate leads to some uncertainty, which in turn brings about risks, most of the risks can be managed through market mechanisms. In other words, the risk of exchange rate fluctuations to economic and financial stability can be minimized by establishing a comprehensive foreign exchange derivatives market.
Since 1994, the formation of the exchange rate mechanism for the renminbi has generally been evolving in a more market-oriented way. However, the process and pace of reform have been interrupted by the Asian financial crisis in 1997, the international financial crisis in 2008, and the COVID-19 pandemic that broke out in early 2020. Especially during the first two crises, the intervention in the foreign exchange market and the strengthening of foreign exchange controls led to the renminbi’s exchange rate losing its function of adjusting the balance of payments and as a macroeconomic tool, aggravating the deflationary effects of the crises, and leading to the emergence of risks such as high leverage.
It is commendable that during the height of the COVID-19 pandemic in early 2020, China’s central bank refrained from normalizing interventions in the foreign exchange market — a practice that was launched at the end of 2016. In particular, on Aug 5, 2019, the onshore and offshore exchange rates of the renminbi dropped below seven to the dollar, which means that China has begun to use flexible exchange rate adjustments as a cushion to absorb external shocks.
It also helps cushion against shocks from changes in the international economic and financial situation and the impact of the pandemic over China’s foreign trade and crossborder capital flows.
Adhering to a rule-based principle means that the rules can be formulated by experts, but decisions over the daily exchange rate should be left to the market. The equilibrium exchange rate cannot be set subjectively. The role of the government is to develop and manage the market.
Some people are worried about whether the internationalization of the renminbi will increase crossborder capital flows, and thereby increase the difficulty of maintaining the stability of the exchange rate of the currency. Such concerns notwithstanding, the rapid internationalization of the renminbi is inseparable from China’s continuous opening-up policies.