The Renminbi — A Victim of its Own Success

Nicholas Consonery (Eurasia Group)



Nicholas Consonery is an Asia Analyst at Eurasia Group.

China’s leadership faces many difficulties these days. Exciting international investors about the Chinese currency, the renminbi, generally isn’t one of them.

In fact, the explosion of the offshore renminbi market in Hong Kong since 2010 is perceived as a major success in Beijing. It will probably go down as the crowning policy achievement of China’s long-serving central bank governor, Zhou Xiaochuan.

While the market is still far from fully developed (see the divergence in the renminbi's value between Hong Kong and the mainland over the past two days), the Hong Kong Monetary Authority’s monthly data shows that RMB deposits in Hong Kong reached $89 billion in dollar equivalent in July, up from just $14 billion in June 2010. That’s a whopping 535% increase in just thirteen months. Renminbi denominated “dim sum” bond issuance, meanwhile, is also growing rapidly—Thomson Reuters estimates that total volume will hit $31 billion in 2011, up from $6.7 billion in 2010.

These numbers raise a series of questions about the Chinese currency. Why is this happening? What does it mean for the trajectory of the renminbi?

The “why this is happening” question is easy. The global economic crisis offered Chinese policymakers both a rationale and an opportunity to press forward on “internationalizing” their currency. And global markets were quick to chase down the ensuing opportunities.

The offshore renminbi market received a serious lift in December 2008, when China’s central bank embarked on a series of bilateral currency swaps with neighboring economies and trading partners worth $121 billion. Beijing also gradually expanded a settlement mechanism that allows Chinese and international firms to conduct cross-border trade in renminbi.

The reason for these moves, as argued by the People’s Bank of China (PBoC) in 2008, was that doing so would help neighboring economies mitigate a dollar liquidity crunch (which pushed intra-Asian trade into a slump during the crisis) by freeing up dollars that otherwise would have been used in trade with China.

And then in July 2010 the offshore renminbi market in Hong Kong exploded, when Beijing and the Hong Kong Monetary Authority amended their clearing arrangements to allow bank-to-bank transfers of the currency in Hong Kong. They also removed restrictions on the amount of renminbi that companies in the city could buy and sell per day.

There are good reasons for Beijing to pursue a more widely used currency. Doing so benefits Chinese competitiveness by protecting domestic export-oriented firms from exchange rate volatility. The government also views its influence in a regional context and is seeking to establish its currency as a leading unit of exchange in Asia as the region becomes more integrated.

But the second question—what this means for the renminbi’s trajectory—is more difficult to answer.

My view is that recent achievements in the offshore market could actually delay the currency’s rise. Indeed, today’s successes might reduce Beijing’s willingness to undertake the difficult reforms that are needed to make their currency competitive as a true global reserve asset.

Why? My reasoning is political. Major economic policy decisions in China are made by consensus among competing interest groups. One of those groups include reform-minded economists and policymakers, like Governor Zhou and PBoC advisor Li Daokui, who have been arguing for years that China should pursue currency and capital account reforms.

But internal resistance to those kinds of reforms, from more conservative and risk-averse policymakers, has been strong (the PBoC has been calling for capital account liberalization since at least 1991, for example). And by developing offshore markets and allowing trade settlement in renminbi, China gets many of the benefits of having a reserve currency—like mitigating exchange rate risk for exporters, and the prestige of maintaining a globally used currency—without actually having to pursue those more difficult reforms.

Put another way, in the internal debates about economic policy, today’s successes will actually benefit the opponents, rather than then proponents, of reform. Conservatives will argue that those reforms are unnecessary, given that the renminbi is already becoming a global currency without them. Reformers will need to work harder to convince the final decision makers that those reforms are needed.

The risk is that the always-cautious Chinese leadership decides that they can have their cake and eat it, too. That’s a worrying scenario for currency reform in China over the next ten years.

More From

More on This Topic