The RMB enigma in internationalization
Updated: 2014-12-17 07:47
By Ho Lok-Sang(HK Edition)
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The launch of the HK-Shanghai Stock Connect, and removal of the 20,000 yuan daily conversion limit, mean that RMB convertibility has taken another step forward. Today RMB is already almost fully convertible.
Looking back, the liberalization of RMB has taken everybody by surprise. In the late 1980s, in a chapter entitled "Whither China's Foreign Exchange Control?" published in China: Modernization in the 1980s (Chinese University of Hong Kong Press) I concluded: "China needs a convertible RMB. In its absence, the drive to modernization will have to proceed along a much more tenuous path." At the time, some policy analysts had proposed the introduction of currencies for the Special Economic Zones, but far-sighted observers such as Gu Mu of China's cabinet, pointed out that such currencies would at best be little more than a short-lived solution to a local problem. The nation badly needed a more permanent answer to its currency problems.
Since then China has merged the "RMB adjustment center rate" and the "official rate" of exchange, and again RMB has appreciated instead of depreciating - to the surprise of most observers at the time.
And yet there are non-believers. A recent article in the Financial Times carried the title: "RMB Internationalization: More Hype than Hope."
The writer agrees that the internationalization of RMB - in the sense of it being used for invoicing or settlement - will continue to rise, but doubts the currency will have much chance of becoming a global, or reserve, currency. Pointing out that the New Development Bank will use US dollars, that China has yet to develop a deeper, trusted financial market infrastructure, and that China is still not prepared for genuine capital market liberalization, he doubts there is much hope that RMB will compete with the US dollar as a major reserve currency.
There is certainly much doubt in the market place over whether China will allow its citizens to freely transfer capital in and out of the country. But, if the funds are legitimate, why shouldn't they? China is currently engaged in struggle against corruption and money laundering. Erring on the side of caution is to be expected, indeed it is necessary. In the longer run, however, there is no reason why China should not allow funds to be transferred freely in and out of the country. The Hong Kong-Shanghai Stock Connect is in fact the first step in this direction.
Nevertheless this does not mean China will let RMB float freely without any intervention. As I posited in my 1989 article, short-term capital movements can be extensive, and highly disruptive, since they can cause a currency to appreciate or depreciate to such an extent that trade and investment plans are affected. Rapid currency appreciation can render exports unprofitable if market share is to be maintained.
In order to cover domestic production costs, export prices of products from countries with strong currencies will have to rise, and that will mean a loss of market share. A refusal to pass on these costs to retail prices in overseas markets will mean exporters suffering huge losses. A few years ago many Japanese exporters suffered considerable losses because of the strong yen. A central element of Abenomics was aggressive quantitative easing to force the yen to depreciate. Since then most Japanese exporters have moved back into profitability.
On the other hand, excessive depreciation also causes serious hardship. Hardest hit will be consumers relying on imported goods for their daily needs. Then there are firms who rely on imported goods and services and whose customers are primarily locals. In the latest round of yen depreciation, a number of firms have already gone bankrupt due to a surge in costs. According to a Teikoku Databank Ltd survey, 42 companies that failed in November claimed the weak yen contributed to their demise.
Moreover, observers agree that the yen's roller-coaster movement in the foreign exchange market is disruptive. Avoiding such gyrations in the RMB exchange rate would be in China's best interests, and this is not incompatible with the full convertibility of RMB. Conceptually, RMB should be fixed at a level compatible with full employment in the economy, and anchored against a basket of currencies. Only when the economic fundamentals change should there be any adjustment in the rate at which the anchor links with the basket.
My reading of policy developments on the mainland is that liberalization of RMB will continue at a steady pace. The Hong Kong-Shanghai Stock Connect is but one of the many steps China is taking to become more integrated with the global economy.
The writer of the Financial Times article says that China would need to run "perpetual external deficits" in order for RMB to become a global or reserve currency. This conclusion shows weak logic. When the US dollar was the only international settlement currency, the world did not require a continuing US current account deficit. But such times are past. The world only needs multiple currencies for invoicing and for settlement.
The author is director of the Centre for Public Policy Studies in Lingnan University.
(HK Edition 12/17/2014 page10)