China has made extraordinary strides towards internationalising the renminbi, and it is now time the international community recognises that the global economic architecture needs to evolve to keep pace with the changes.
While the world has been focusing on Europe's woes and America's new stimulus programme, the renminbi quietly passed another key milestone on its path towards becoming a global currency. Last July, the yield spread between five-year onshore Chinese government bonds and those traded on overseas exchanges narrowed to just 9 basis points. A year earlier, the spread stood at almost 300 points.
The higher price paid by onshore borrowers last year reflected the frictional costs created by Chinese controls. The convergence of the bond yield is an unequivocal vote of confidence in Beijing's programme of currency normalisation.
The disappearance of the yield spread, and the broadly shared agreement that the renminbi has reached market equilibrium with the US dollar, are clear indications that the walls that have sequestered the Chinese currency from the global economy are crumbling fast.
The Chinese government has made substantial progress on all the three key steps to full convertibility of the renminbi: deepening and liberalising the local capital markets; relaxing restrictions on the exchange rate; and allowing the markets greater say in setting interest rates.
The Qualified Foreign Institutional Investor programme, which gives foreigners direct access to China's capital markets, has been expanded by US$7.3 billion so far this year to US$29.8 illion; the onshore interbank market is being liberalised; interest rates have been allowed to float 10 per cent above and 30 per cent below the rate set by the People's Bank of China; and the daily amount which the renminbi can fluctuate has been doubled to 2 per cent.
September's creation of a deliverable renminbi futures exchange in Hong Kong also marks a key step in establishing a functioning feedback loop for market-set exchange rates, as do the memoranda of understanding signed with Singapore and Taiwan to open renminbi clearing centres.
The process of internationalisation is accelerating, driven principally by growth in trade settlement. China first permitted trade renminbi settlement in 2009, and since then it has grown to account for more than 10 per cent of China's total trade, and continues to expand.
The recent plateauing of the growth of yuan deposits in Hong Kong, at about 550 billion yuan (HK$678 billion), has been mistakenly interpreted by some analysts as an indication of slowing market interest in the currency itself and the internationalisation project more broadly. But the slowdown in deposits is a mark of success rather than weakness. Some speculative investment has been driven out of the market since the renminbi reached equilibrium with the dollar, and other funds have migrated over the border into the onshore market.
The market for dim sum bonds is also slowing but the sum raised so far this year is still higher than last year's total.
We believe that benchmark offshore renminbi yields will eventually move higher than their onshore equivalents as investors gravitate towards the greater return, depth and variety of mainland Chinese debt.
Of course, the full convertibility of the renminbi is still some way off. The Chinese domestic bond markets are currently worth 22 trillion yuan, a fraction of the US$37 trillion American or the €14.8 trillion (HK$149 trillion) European markets, and dismantling the remaining capital controls will be a delicate process not without risk for the Chinese government and the economy more generally.
The central government is pressing ahead with reform with impressive speed: it is worth remembering that some European nations took 20 years to achieve full convertibility.
Given the importance of China to the global economy, there is a growing hunger for an alternative to the US dollar.
Recent research by Arvind Subramanian and Martin Kessler of the Peterson Institute for International Economics indicates that the renminbi has already superseded the dollar as the most important reference currency for most East Asian economies. It is a trend that is likely to accelerate. The People's Bank of China has signed currency swap deals with Mongolia, South Korea, Japan and Australia among others; and some countries, including Nigeria and Chile, are already dipping their toes into the renminbi-as- reserve waters.
Now, the outside world must consider what steps it needs to take to assist and reward the Chinese government for their bold moves towards internationalisation.
We need to recognise that a global reserve regime that stands on three legs is going to be more stable, particularly given the current uncertainties in Europe and the US, and take active and meaningful steps to support China's efforts.
The global community, as controllers of the International Monetary Fund, should fast-track the renminbi's inclusion into the basket of currencies used to determine the value of special drawing rights (SDR), a move that will reinforce the reforms now under way in Beijing.
The recent loosening of restrictions on the renminbi means that it now broadly satisfies the conditions laid down by the IMF in November last year, when they said that the next SDR meeting isn't due until 2015, "or earlier if the Fund finds changed circumstances warrant an earlier review, to ensure that it reflects the relative importance of currencies in the world's trading and financial systems".
The signals being sent by the bond and foreign exchange markets are clear: the renminbi is getting ready for formal international recognition.
Anita Fung is chief executive officer of HSBC Hong Kong