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Renminbi may become global reserve currency

Publication Date : 28-02-2014

 

The renminbi could rival the US dollar as a leading international reserve currency despite obvious challenges, said Yves Mersch, a member of the European Central Bank's executive board.

Delivering a keynote speech on Wednesday at The Luxembourg Renminbi Forum, Mersche said that the currency's internationalisation is just beginning, but it's moving fast.

"Clearly, having become an important trading and payment currency, the renminbi is now taking the first steps toward establishing itself as an international investment currency. If it can do so successfully, it might one day become a leading reserve currency," he said.

China's push to internationalise its currency started in 2008, when the global financial crisis demonstrated the danger of excessive reliance on the US dollar.

China soon began to encourage the use of its currency in international trade, swap arrangements among central banks, and bank deposits and bond issues in Hong Kong.

European businesses increasingly started to invoice Chinese suppliers using the yuan, creating a growing offshore pool of the currency in Europe. With the expansion of Chinese banks in Europe, yuan-denominated trade finance and investment products are also increasingly available.

"Trade in offshore renminbi has boomed. Increasing Chinese exports also led to a surge in demand for renminbi outside China as Chinese exporters increasingly expect to be paid in their own currency to eliminate exchange risks," Mersch said.

But he added that the growth of offshore yuan activity faces challenges, one of which is the fragmentation between the onshore and offshore markets.

The onshore currency isn't freely convertible, unlike the offshore pool of renminbi. Exchange rates are also different.

"Offshore and onshore markets are only partially integrated so far. This results in small but persistent discrepancies in exchange and interest rates between the onshore markets and offshore markets," Mersch said.

Market fragmentation also creates liquidity risk, such as when an offshore investor faces a "sudden and temporary renminbi shortage that cannot be met by quick transferring from the mainland", Mersch said.

Mersch said the renminbi swap line signed between the ECB and the People's Bank of China last October will help to address this liquidity problem. The swap line is valid for three years and has a maximum size of 350 billion yuan ($57.1 billion).

Swap agreements allow central banks to address liquidity problems. Renminbi swap lines with foreign central banks boost overseas investors' confidence in yuan-denominated investments.

Mersch added that further liberalisation of financial flows by China would promote further integration of the onshore and offshore markets.

He said the integration of the currency into the world financial system would require continued development of the relevant payment infrastructure, and ultimately the integration of onshore and offshore activities, so that cross-border renminbi payments can be processed quickly and efficiently.

European regulators are also striving to devise appropriate methods to regulate growing yuan-denominated transactions in the eurozone, Mersch said.

The increasing presence of Chinese banks in the euro area also brings its own challenges regarding banking supervision, including the need for greater international cooperation and exchange of information, he said.

Mersch said the yuan's internationalisation could have a significant impact on the international financial landscape.

But he warned that "it is too early to say what the implications for international financial stability could be".

 

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