Yuan hailed as the world reserve currency
Some serious supporters say the yuan's day as a challenge to the greenback has come. But it depends on Beijing accepting the downsides
Its supporters excitedly describe it as rise of the "redback" - red for communist China as opposed to the greenback of the US. Now two distinguished academics have joined a chorus of bankers anxious to share in the lucrative business opportunities they see in the internationalisation of the yuan to challenge the US dollar as the global currency of choice.
Anita Fung, Hong Kong chief executive of HSBC, is among the most gung-ho believers that China's day has come. "The signals being sent by the bond and foreign exchange markets are clear: the renminbi is getting ready for formal international recognition," she declared in this newspaper last month.
Not so fast: is the government in Beijing OK with this? Official approval is necessary in the progress towards greater international use of the currency.
It is easy to understand the pressures for China's currency to become an international reserve currency. The system of international reserve currencies is clearly battered and broken. The paucity of currency choices is sending foreign exchange markets into a complicated variant of the pass-the-parcel game where no one likes to hold on to what they have got, and with good reason. The US dollar scores by force of habit and convenience, but who wants the currency of a country on the edge of a fiscal and debt cliff?
Apart from the dollar there is the euro, whose union is on the brink of disintegration; the British pound, another country in a mess; the Japanese yen, whose rise to a safe-haven role is wrecking the already wretched economy, plus "other currencies".
The US dollar accounts for more than US$3 trillion of global reserve assets, followed by the euro, with about US$1.2 trillion, and the yen and pound with a few hundred billion equivalent dollars each. The fact that these figures are expressed in terms of US dollars, shows the dominance of the currency, which accounts for about 60 per cent of allocated global exchange reserves.
Supporters of the yuan correctly claim that it has made great progress as a working international currency. Fung points to "substantial progress" on the key areas to full convertibility of the currency: deepening and liberalising local capital markets; relaxing restrictions on the exchange rate; and allowing greater market say in setting interest rates.
The qualified foreign institutional investor programme, giving foreigners direct access to China's capital markets, has been expanded to US$29.8 billion; the onshore interbank market is being liberalised; and the daily limit for currency fluctuations has been doubled to 2 per cent.
In addition, creation of Hong Kong's deliverable yuan futures exchange and memoranda of understanding for yuan clearing centres in Singapore and Taiwan are important steps to encourage market-set exchange rates.
Trade settlement in yuan, first permitted in 2009, is expanding and accounts for 10 per cent of total mainland trade.
China's central bank said more than 60,000 companies worldwide have permission to do transactions in the currency. Some importers from China say they are getting discounts of up to 7 per cent by paying for goods in yuan, a powerful incentive.
Cumbersome payment procedures, especially for onshore payments where three detailed pieces of paper have to be submitted and tallied, are dragging the expansion of yuan trade, a reminder of the power of Beijing's officialdom.
Now two academics, Arvind Subramanian and Martin Kessler of the respected Peterson Institute for International Economics, have developed a formula, which claims that the yuan already has taken over from the US dollar as the most important reference currency over large areas of Asia.
They contend that "in East Asia, there is already a renminbi bloc, because the renminbi has become the dominant reference currency, eclipsing the dollar … seven currencies out of 10 co-move more closely with the renminbi than with the dollar".
Professor Michael Pettis, of Peking University, sniffs about Subramanian and Kessler's claim that "there is a lot less to this than meets the eye". He maintains that being the world's dominant economy does not always mean being the international reserve currency, or vice versa.
Arguments rage over whether being an international reserve currency is a blessing or a curse to the issuing country. America can borrow more cheaply and without the risk of sudden exchange rate shifts. But there is also a price to pay, which Beijing has been reluctant to accept: a reserve currency is at the mercy of winds and tides of external economic forces. Pettis pertinently puts it: "Major reserve currency status would require complete liberalisation of the capital account and a flexible financial system largely independent of government control, with clear and enforceable rules."
In addition, "It would put China's economy at the mercy of countries that want to turbo charge growth by running large trade surpluses. Beijing isn't eager to accept any of these things."
The woman on the Beijing street with redbacks to do business, visit relatives or travel may have to wait for their widespread acceptance at a good rate outside Hong Kong.