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UPDATED: November 4, 2014 NO. 45, NOVEMBER 6, 2014
Currency Express
The Chinese yuan has undergone a giant leap with RMB bonds issued in London and direct trading with the Singapore dollar
By Zhou Xiaoyan

According to a report from the International Monetary Institute (IMI) under Renmin University of China, the yuan is expected to become the world's third largest currency, second only to the U.S. dollar and the euro, in the next three to five years.

Li Daokui, Dean of The Schwarzman Scholars Program at Tsinghua University, also predicted that the yuan will become one of the three most important currencies in the world within half a decade.

"In the next five years, cross-border use of the renminbi in financial sector will be a breakthrough in the currency's internationalization," Li said. "If no major crises occur, I foresee the RMB becoming as important as the U.S. dollar and the euro in the international financial community through supplanting the Japanese yen and the British pound in trade settlement and in financial transactions."

Not so fast

Although the renminbi has made remarkable strides, it lags far behind in terms of being used in investment and as a reserve currency, read a report from Beijing-based Anbound Consulting.

People shouldn't have their heads turned because of the stunning success made in renminbi cross-border clearing and settlement, read the report.

According to the report, the internationalization of the renminbi requires supporting systems such as a globalized legal system and policies and institutional arrangements in the financial sector. China's regulatory authorities and financial markets are far from being ready in this regard. Right now, they fear the overseas use of the renminbi will deal a heavy blow to domestic monetary policies, read the report.

The purpose of the yuan's internationalization shouldn't be to replace the U.S. dollar or the euro, but to add more flexibility to the international monetary system in a volatile international financial market. In the future, the international monetary system will be more diversified and no currency will be able to dominate the system as the U.S. dollar currently does. Becoming an international currency means incurring more risks as well as taking on more responsibility, read the report from Anbound Consulting.

Xiao Lei, a financial commentator, said use of the yuan as a reserve currency has a lot of catching up to do compared to its employment in cross-border trade settlement.

"In order to realize complete globalization of the currency, large strides should be made on reforms of China's financial markets, including the stock market, bond market, banking system and the money market. Whether or not the renminbi era will arrive and how soon that happens largely depends on how successfully China's financial reforms are carried out," Xiao said. "It's not a war against the U.S. dollar, rather a war within the country."

Tan Xiaofen, an associate professor in finance at the Beijing-based Central University for Finance and Economics, said the yuan becoming a top trade settlement currency represents only a preliminary stage in its internationalization.

"An international currency should have three functions: firstly to be used in trade settlement; then to be used in investment, as in the issuance of renminbi-denominated bonds; and finally as a reserve currency," Tan said.

Tan said this requires more from China's domestic financial markets. He said the reason the U.S. dollar enjoys such an unshakable global status can be a large extent attributed to its highly refined and developed financial markets, which can draw much foreign investment.

"In addition, the internationalization of the yuan should be driven by the demand of the real economy, ordinary people, businesses and financial institutions, rather than being spearheaded by the government," he said.

Lian Ping, chief economist at the Bank of Communications, said conspicuous imbalances have to be taken into consideration concerning the internationalization of the yuan. Renminbi settlement in cross-border trade is mainly used in trade between China and the Association of Southeast Asian Nations, but not so much in China's trade with its major trade partners the EU and the United States. Meanwhile, the size of offshore yuan markets is very limited and the renminbi backflow system still needs to be improved.

Lian said whether or not the yuan's internationalization will make substantive progress in the next five years depends on many variables, which include improving China's financial markets, steadily pushing forward convertibility under the capital account, developing offshore yuan hubs, optimizing the yuan backflow system, accelerating market-oriented reforms on interest rates and exchange rates and expanding outbound investment using yuan.

"The internationalization of the yuan can't be accomplished in one fell swoop. It would be impractical to expect instant success," Lian said.

Email us at: zhouxiaoyan@bjreview.com

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