• Sourcing Solutions
  • Services & Membership
  • Help & Community
Buyer Community> Trade Intelligence> news> China internationalize only when wise
Source: China Daily China Daily

China internationalize only when wise

Published: 25 Feb 2015 01:21:16 PST

China internationalize only when wise

Academic says it is wrong for China to strive for rapid renminbi internationalization without questioning its effect on the Chinese economy. [Photos provided to China Daily]

China's opening capital account controls should be used to help Chinese economy, academic says

China should liberalize its capital account controls and foreign exchange rate controls at a speed that benefits its economic growth, says Yu Yongding, an academic of the Chinese Academy of Social Sciences.

Yu, who is also a senior fellow with the Institute of World Economics and Politics, a Chinese government think-tank and research center, says it is wrong for China to strive for rapid renminbi internationalization without questioning its effect on the Chinese economy.

"We often forget why we hope to internationalize the renminbi in the first place, but it is important to remember this because renminbi internationalization policies should only be pursued to aid long-term economic growth," Yu says.

Yu was speaking during this year's LSE SU China Development Forum in February, hosted by the London School of Economics and Political Science's student union.

Although China has gradually opened its capital account controls in recent years, allowing greater cross-border yuan flows in both directions, there are still many measures in place to restrict the flow of money to prevent sudden inflows or outflows of renminbi, which can be destructive for economic growth.

This is particularly true in the context of the so-called global currency war, which Yu says China is a reluctant participant in. Because currency policies of other countries greatly affect China's economy, such as the severe quantitative easing practiced by the United States after the global financial crisis, the Chinese government needs to step in to intervene.

Yu proposes that some controls can be loosened further, like the current 2 percent daily trading band against the dollar being increased, to encourage more flexibility for the renminbi and increase unpredictability of the currency fluctuation.

Other controls, such as the current cap of $50,000 yearly that individuals can convert from renminbi to other currencies, can be gradually increased if the individuals have special needs, such as going overseas for education.

Furthermore, the tight regulations and complex processes involved in the granting of approvals for international investments by Chinese companies should be further relaxed, so that Chinese companies venturing abroad with legitimate investment plans can be further encouraged.

China's push to internationalize its currency started in 2008, when the global financial crisis demonstrated the danger of overreliance on the US dollar.

During the G20 summit in November 2008, then Chinese president Hu Jintao called for "a new international financial order that is fair, just, inclusive and orderly".

Beijing soon began to encourage the use of its currency in international trade, swap arrangements among central banks, and bank deposits and bond issuances in Hong Kong.


China internationalize only when wise

Trade in offshore renminbi has since boomed. Increasing Chinese exports also led to a surge in demand for renminbi outside China as Chinese exporters increasingly expect to be paid in their own currency to eliminate exchange risks.

But Yu points out that one major challenge of China's currency liberalization is the increase in speculative flows, because China's higher interest rate attracts more inward flows to earn carry trade. Investopedia.com defines carry trade as a strategy in which an investor sells a certain currency with a relatively low interest rate and uses the funds to buy a different currency yielding a higher interest rate, in order to capture the difference between rates.

In the early years of China's currency liberalization, much of the speculative inflows were hoping to gain from the continual renminbi appreciation, which is another challenge.

But this trend is now gradually reversing as the renminbi exchange rate has now reached equilibrium with the US dollar, and as the Chinese economy slows down and its capital account surplus is reduced, there is now depreciation pressure on the renminbi and an outflow of renminbi.

Yu says that although many economists believe such renminbi outflow will affect the renminbi internationalization process, that China should further stabilize the renminbi exchange rate to encourage renminbi internationalization, this is not the correct attitude.

In the face of these challenges, Yu says, it is important to reflect why China wants to internationalize its currency in the first place, which Yu summarizes as having five key goals.

The first is to reduce currency exchange risks, the second is to help China's financial services industry grow and become internationally competitive, and the third is to reduce China's large accumulation of foreign exchange reserves.

The fourth is to reduce the costs of exchanging renminbi with other currencies, and finally there is the hope that the renminbi can become a global reserve currency.

Yu says many of these goals have been somewhat achieved by China's renminbi internationalization, such as the internationalization of China's financial services industry, but more of the objectives have not yet been well achieved.

For example, the goal of reducing renminbi exchange risks for international trade has not been achieved thoroughly because much of the international trade is not yet being transacted in renminbi. China's foreign reserves accumulation has also not been reduced, but actually increased due to speculative inflows.

The goal of helping renminbi to become a global reserve currency has experienced some milestones, as several foreign central banks have now decided to hold a small proportion of their foreign reserves in renminbi.

However, the gain from carry trade from holding the renminbi is one key motivation for such measures. This means China is paying out a large amount of interest to foreign central banks for holding its currency over the years.


"China has gained a lot from its currency's internationalization, but such progress is also made with significant costs," Yu says.

He says China should not completely open its capital account controls, as currency stability is an essential part of having a stable economy.

One major issue for China currently is its high M2 to GDP ratio, meaning much of the country's money is concentrated in the hands of a few, and opening up capital account controls too quickly could lead to capital flight, Yu says.

"Although there are no actual figures, there is a lot of anecdotal evidence that many corrupt officials are putting their money offshore, in jurisdictions like the Virgin Islands or Cayman Islands. This could generate a very large capital outflow if adequate controls are not put in place."

Although China's central bank has previously set a target to make the renminbi partly convertible by this year and fully convertible by 2020, Yu believes the mindset of having such a target is not right.

Instead, the correct method is to segment different market players' needs, encouraging foreign direct investment flows into and out of China when there is a real economic need for such flows, but restrict speculative flows.

In the long term, Yu says the renminbi needs to be fully convertible for it to be a global reserve currency, because a reserve currency is one that can be freely traded by those who hold it, so it requires high liquidity.

And in the short term, it is still important for the Chinese central bank to use exchange rate controls to stabilize economic growth in reaction to monetary policies practiced by other international major economies, and the quantitative easing about to be implemented in Europe could be an example of this.

According to European Central Bank announcements last month, at least 1.1 trillion euros will be injected into the ailing eurozone economy, and the program is expected to start next month.

"The QE in Europe could have very negative consequences for the Chinese economy, and it is our priority to guard our economic growth against such big shocks.

"We are already in a currency war. So either we have international coordination to have no intervention by governments in our financial markets, or alternatively we will need to intervene to reduce adverse effects on our economy that other countries' monetary policies are causing," Yu says.

Share this post:
Related Article
Most Popular