RMB Internationalisation: Short-term Tactics May have Changed

23 Feb 2016

Change will not come if we wait for some other person or some other time. We are the ones we’ve been waiting for. We are the change that we seek. Barack Obama

SUMMARY

  • Changes in economic conditions since 2014 both in China and globally may have prompted Beijing to sharply slow the process of renminbi internationalisation in the short-term. This implies that Beijing may have also downgraded the policy priority of capital account liberalisation.
  • An indicator of this, in my view, is the heavy intervention by the People’s Bank of China in the offshore FX market this January, which pushed up the overnight offshore renminbi inter-bank lending rate to over 60%. Beijing seems to be willing to “sacrifice” the offshore market in favour of domestic priorities.
  • Beijing reckons that renminbi internationalisation may carry more risks than benefits at this stage of the economic transition. This underscores our long-held view that renminbi internationalisation based on currency movement speculation would not be sustainable.

WHAT HAS CHANGED?

Renminbi internationalisation, in conjunction with a strong FX policy bias, was once a high policy priority in facilitating China’s financial liberalisation. However, several developments since late 2014 may have caused Beijing to stall the internationalisation strategy.

Firstly, changing global growth and interest rate dynamics have dented Beijing’s strong renminbi policy stance. When China’s economic growth was strong and US’s growth was weak before 2014, it was easy for China to defend a strong currency bias. But between late 2014 and 2105, US growth continued to recover, the US dollar rose by 20% against all major currencies and the US raised interest rate (in December 2015) for the first time since the Great Financial Crisis. Meanwhile, China’s growth remained weak and the PBoC cut interest rates six times.

Firstly, changing global growth and interest rate dynamics have dented Beijing’s strong renminbi policy stance. When China’s economic growth was strong and US’s growth was weak before 2014, it was easy for China to defend a strong currency bias. But between late 2014 and 2105, US growth continued to recover, the US dollar rose by 20% against all major currencies and the US raised interest rate (in December 2015) for the first time since the Great Financial Crisis. Meanwhile, China’s growth remained weak and the PBoC cut interest rates six times.

Secondly, from Beijing’s perspectives, the role of renminbi internationalisation as a force to push through financial deregulation has largely been completed1. Hence, its official importance has diminished. To gain the renminbi’s entry to the Special Drawing Rights (SDR) basket, Beijing scrapped the deposit interest rate cap (in July 2015), and shifted its exchange-rate mechanism from a de facto US dollar peg to a more flexible one (in August 2015) allowing more market forces to drive the renminbi-US dollar cross rate with two-way volatility. It also implemented a series of other opening-up measures to increase access to China’s onshore markets (see Table 1). The admission of the renminbi to the SDR basket in December 2015 was seen as an international recognition of China’s achievement in financial liberalisation.

Thirdly, renminbi internationalisation seems to have turned from a political boon to a bane for Beijing. The success of the CNH market in making the renminbi more widely used has also allowed offshore players to sell short the Chinese currency. This has created unwelcome volatility in the internationalisation process just when the pressure of structural rebalancing on China’s domestic economy is also intensifying.

China signed swap lines with more than 30 foreign central banks, but they seem to have backfired on renminbi internationalisation. In late December 2015, the central bank of Argentina unexpectedly activated its renminbi swap line with the PBoC, acquiring renminbi and swapping it for US dollars to replenish its depleted reserves. While the swapped amount was small (USD3 billion), its implication was significant.

If other central banks start following Argentina’s lead and use their renminbi swap lines to acquire US dollars, they would put significant selling pressure on the renminbi. Rather than encouraging the international use of the renminbi to stabilise international FX markets, the renminbi swap lines might ironically end up strengthening the US dollar and causing more FX volatility at the expense of the renminbi.

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