The Renminbi as a Trading Currency: Evidence from Selected Countries Participating in the Belt and Road Initiative

• Date: 01 September 2020
• Author: Yingting Li,Haihong Gao
• DOI: http://doi.org/10.1111/cwe.12352
• Published date: 01 September 2020

©2020 Institute of World Economics and Politics, Chinese Academy of Social Sciences

China & World Economy / 45–63, Vol. 28, No. 5, 2020 45

*Haihong Gao, Senior Fellow, Institute of World Economics and Politics, Chinese Academy of Social Sciences,

China. Email: gaohh@cass.org.cn; Yingting Li, PhD Candidate, Graduate School of Chinese Academy of Social

Sciences, China. Email: yingtingli95@163.com.

The Renminbi as a Trading Currency:

Evidence from Selected Countries Participating

in the Belt and Road Initiative

Haihong Gao, Yingting Li*

Abstract

This paper investigates the effects of the renminbi (RMB) exchange rate on trade prices

and volumes in selected Belt and Road Initiative (BRI) countries in comparison with the

effects of the US dollar. The stylized facts show that the RMB is underused in bilateral

trade with selected BRI countries where intermediate goods dominate. By estimating the

level of exchange rate pass-through and trade volume elasticity, we fi nd that the RMB is

signifi cantly correlated with the volume of imports in the sample countries, predicted by

the producer currency pricing (PCP) paradigm. We also regroup intermediate and fi nal

goods between China and the BRI countries. The evidence shows that dollar fl uctuation

affects export volumes, refl ecting the role of the US as a fi nal goods destination, whereas

the RMB exerts a signifi cant impact on the volume of intermediate goods imported from

China to the sample countries due to China’s important position in global value chains.

Key words: Belt and Road Initiative, exchange rate pass-through, RMB internationalization,

trade volume elasticity

JEL codes: E520, F310, F410

I. Introduction

In the past decade, the internationalization of the renminbi (RMB) has gained

momentum. China’s rising economic power in the world has provided a solid basis

for the international use of the RMB. More important, China’s achievement in capital

account liberalization, exchange rate system reform, and domestic financial market

development has strongly supported the RMB’s status as an international currency (Gao,

2018). In 2016, the International Monetary Fund (IMF) added the RMB to the special

drawing rights (SDR) basket with a weight of 10.92 percent. The RMB has also become

Haihong Gao, Yingting Li / 45–63, Vol. 28, No. 5, 2020

©2020 Institute of World Economics and Politics, Chinese Academy of Social Sciences

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the fi fth to seventh most frequently used currency for international payments. Moreover,

Cheung et al. (2019) find that the locations of trading of the RMB have expanded

globally in the past years.

However, the current use of the RMB in international payment is much lower

than the share China has in international trade. On the other hand, the US dollar plays

a dominant role in international payment, and this is much higher than what might

be expected from US participation in international trade. There exists a mismatch

between the currencies’ share in international payment and the US and China’s share

of international trade. Gopinath et al. (2020) suggest that the dollar has a dominant

position in international payments by examining the impacts of the bilateral exchange

rate between the trading partners and the bilateral exchange rate with the dollar on

trade prices and volumes. There are two streams of literature discussing the relationship

between exchange rate fl uctuation and the level of international trade, which respectively

focus on the extent of the exchange rate pass-through (ERPT) and the elasticity of trade

volume.

The effect of the ERPT is one of the channels connecting the exchange rate of

invoicing currencies and international trade levels. The invoicing currency adopted by

fi rms might be the domestic currency of producers, the local currency of the destination

country, or the currency of a third country. Obstfeld and Rogoff (1995) build a redux

open-economy model that includs micro-foundations in the explanation of exchange rate

dynamics. Their model features a dynamic two-country framework, within which each

country contains both producers and consumers, has incomplete markets and nominal

rigidities, and invoices its exports in the domestic currency, i.e. it follows the producer

currency pricing (PCP) paradigm. Based on the redux model, the collection of the new

open economy macroeconomics models has been enriched by relaxing the assumptions

of the PCP paradigm. Betts and Devereux (1996) assume local currency pricing

(LCP) and segmented markets, in which case exchange-rate fl uctuations would lead to

distortions in the terms of trade. By considering trade costs and imperfect competition

with variable markups, Atkeson and Burstein (2008) fi nd that different levels of market

shares across fi rms within the same sector generate pricing-to-market behavior, which

justifi es the LCP paradigm. Goldberg and Tille (2008) point out that many countries use

the US dollar for invoicing in international trade, which provides evidence for vehicle

currency pricing (VCP). Chung (2016) confi rms the VCP paradigm with evidence that

firms with high levels of imported inputs denominated in vehicle currency are more

likely to adopt VCP. In addition to VCP, the model presented by Gopinath et al. (2020)

suggests the existence of a dominant currency pricing (DCP) paradigm, in which the

dollar is the dominant currency whose exchange rate fluctuations affect the levels of