Renminbi Internationalization in the New Normal: Progress, Determinants and Policy Discussions

• DOI: http://doi.org/10.1111/cwe.12192
• Published date: 01 March 2017
• Author: Cheng Li,Xiaojing Zhang
• Date: 01 March 2017

Renminbi Internationalization in the New Normal

22 China & World Economy / 22–44, Vol. 25, No. 2, 2017

©2017 Institute of World Economics and Politics, Chinese Academy of Social Sciences

Renminbi Internationalization in the New Normal:

Progress, Determinants and Policy Discussions

Cheng Li, Xiaojing Zhang*

Abstract

In the present paper we explore the internationalization of the renminbi with reference

to the experiences of other monetary powers, and discuss its determinants, prospects

and implications for China’s development in the “new normal.” Specifically, after

summarizing the major progress made thus far, we conduct a regression analysis,

showing that economic size and financial conditions are significant determinants of

the international currency status, while inertia and other unobserved factors also play

important roles. These empirical fi ndings enable us to undertake a scenario analysis

focusing on the renminbi’s potential to become a global reserve currency. Based on this

quantitative research, we then revisit China’s policy initiatives designed to promote

its currency overseas. In our view, the internationalization of the renminbi, along with

financial deepening and liberalization, should be reg arded as a means to achieve

China’s goal of reaching a more sustainable and balanced model of development.

Key words: fi nancial development, international currency, panel data, renminbi

JEL codes: F33, G15, O16

I. Introduction

In the wake of the global fi nancial crisis of 2008 and the subsequent Great Recession,

debate about reshaping the international monetary architecture, especially about the

emergence of a multi-currency system, has been reignited. It is in this context that

China, as an increasingly important player both in international trade and financial

*Cheng Li (corresponding author), Associate Professor, Institute of Economics, Chinese Academy of Social

Sciences, China. Email: licheng@cass.org.cn; Xiaojing Zhang, Professor, Academic Division of Economics,

Chinese Academy of Social Sciences, China. Email: xjzhang@neri.org.cn. The authors thank Ashley Esarey,

Gordon Houlden, Jeffrey Sachs, Wing Thye Woo, Yingfeng Xu and two anonymous reviewers for helpful

comments and suggestions. Cheng Li is also grateful to the staff at China Institute, University of Alberta for

excellent research assistance. Financial support from China Scholarship Council (Grant No. 201404920002)

and from National Natural Science Foundation of China (Grant No. 71603275) is gratefully acknowledged.

23

Renminbi Internationalization in the New Normal

©2017 Institute of World Economics and Politics, Chinese Academy of Social Sciences

China & World Economy / 22–44, Vol. 25, No. 2, 2017

markets, has continued to promote the international presence of its national currency,

the renminbi (RMB, or Chinese yuan). Since recently, China has been transitioning to a

new period of economic and social development, sometimes called t he “new normal,”

in which the country's actual output growth and long-run potential are both slowing

down.1 The economy as a whole, however, shows signs of becoming more sustainable

and balanced due to a series of structural adjustments in favor of domestic demand,

innovation and the service sector. Meanwhile, noticeable changes have been refl ected

in China’s fi nancial conditions, such as the slowdown and even the reversal of China’s

accumulation of foreign exchange reserves, the ongoing capital account liberalization,

the further development of multi-layered capital markets, the inclusion of the yuan in the

Special Drawing Rights (SDR) basket, the end of the one-way appreciation expectation

of the yuan exchange rate against the dollar, and more frequent two-way cross-border

capital flows. All these new trends are emerging at the same time as the focus of

China’s strategy of globalization has moved from expanding trade and attracting foreign

investment to deeper and multi-dimensional integration into the global economic and

fi nancial system. In this context, the internationalization of the RMB, previously viewed

as a short-term policy response to promote trade and reduce the dependence on assets

denominated in foreign currencies, now serves as a major component of China’s long-

term strategies geared toward fi nancial sophistication, industrial upgrading, sustainable

development and structural transformation.

Bearing in mind elementary monetary economics, the internationalization of

the RMB implies that the currency will be more widely used in cross-border trade

settlement and invoicing as well as fi nancial transactions, and held in currency reserves.

As suggested by conventional wisdom, greater monetary power would help China to

curb foreign exchange risk, deal with currency mismatching in external fi nancing, gain

seignorage, and exploit competitive advantages of China’s fi nancial institutions vis-à-

vis foreign competitors. Besides these benefi ts, the RMB internationalization might also

“add momentum to reforms” (Ma et al., 2012). Indeed, it is widely argued that China’s

fi nancial system suffers from serious problems, including a lack of non-state and foreign

competitors, excessive regulations and imperfect market structures (see Allen et al.,

2005 and Song et al., 2011). In this regard, the benefi t from the deepening of fi nancial

reforms could be a primary motivating factor for China to promote the international use

of its currency.

Nonetheless, there are heavy costs associated with this strategy. Because the

1As a matter of fact, China’s GDP slowed to 7.3 percent in 2014, and further down to 6.9 percent in 2015,

whereas the average growth rate over 1978–2013 was 9.9 percent.