While major advanced countries including U.S. has conducted unconventional monetary easing since the global financial crisis, China has aggressively strived to internationalize its currency, yuan. The internationalization of Chinese yuan is based on reducing China’s dependence on U.S. dollar and enlarging its impact on international monetary and financial order as G-2.
Considering its early stages of financial account opening and less mature domestic financial markets, China pursued to develop offshore renminbi market and gradual opening of its domestic markets. For this purpose, China set the long-run goal of shifting Chinese yuan to the reserve currency in international financial markets, while focusing on the expansion of trade settlement by renminbi in the mean time.
As a starting point of renminbi internationalization, trade settlement has increased faster than expected. As of 2014, Chinese yuan accounts for 24% of total trade settlement in China. In addition, yuan is ranked No.5 in the global trade settlement, following U.S. dollar, euro, British pound and Japanese yen. Within the border, Chinese government allowed outward renminbi remittance and loan through financial special districts.
At the same time, various policies such as designation of yuan clearing and settlement banks in the offshore markets, real time payment and settlement system and bilateral swap agreements have been introduced to promote the offshore markets. Now, yuan clearing and settlement banks have been designated in 15 countries and there are 33 countries who signed the bilateral swap contracts. As a result of the continued efforts, offshore financial markets have prospered. Offshore renminbi deposits reached 2 trillion dollars at the end of 2014. In addition, offshore yuan-denominated bond outstanding was 95.4 billion dollars. In addition, the inbound investment channels such as RQFII and Shanghai-Hong Kong stock connect have been implemented recently.
With this policy effort by Chinese government, many economies including Hong Kong, Singapore, Taiwan and the United Kingdom are trying to utilize the renminbi internationalization as their new opportunity by promoting the yuan-denominated financial trading in their domestic financial markets. Especially, Hong Kong is a leading economy to develop offshore renminbi markets, using its established status as international financial center and close ties with Chinese government. Korea also started to build yuan-trading infrastructure such as the designation of clearing and settlement bank and Korean won-yuan direct trading market opening since the Korea-China summit in 2014.
61% of RQFII quota granted to Korea was already approved to the Korean financial institutions and the trading volume at the won-yuan foreign exchange market is high, even though yuan still accounts for very small share of trade settlement between the two countries.
It’s difficult to predict how fast yuan internalization will progress to be equal to the status of U.S. dollar and euro in the global financial market. Until now, Chinese financial account opening remains at the early stage and the prerequisites to become the reserve currency such as mature financial markets are not met. While its economic size is large enough for renminbi to become one of key currencies in international financial market, it is not as attractive as the other reserve currencies in terms of the small share in international bond markets and relatively closed domestic financial markets.
China has had strong trade linkage with regional Asian countries, and now it becomes increasingly connected to the global economy as a whole. In addition, Chinese efforts to make yuan exchange rate flexible may raise the possibility of making the regional economy ‘yuan bloc’. In this case, the impact of yuan exchange rates on regional currencies will be expected to grow. Empirical results based on several methodologies in this research also confirm the increased impact of yuan since its internationalization policy has been conducted.
This implies that yuan is now replacing for the role as the reference currency once Japanese yen has taken in the region. If the Chinese financial markets become more open to the foreign investors, the impact of yuan on regional financial markets and economy will increase with the yuan bloc strengthened.
Recent inclusion of renminbi into IMF SDR basket will contribute to raising its demand and status in international financial markets. In the long run, Chinese yuan is expected to rise as one of the key international currencies and to impact the current dollar-centered financial order. For the time being, the status of U.S. dollar supported by the largest economy and most developed financial markets in the world will be maintained, but it is likely that the global monetary system will shift to the multi-polar regime.
The change of regional and international financial order in response to Chinese yuan’s emerging is expected to have significant impacts on the Korean economy. Its positive aspects include greater macroeconomic resilience by promoting the Korea-China trade and reducing Korea’s dependence on U.S. dollar. In addition, the portfolio investment to China as well as the inflows of Chinese capital to Korean financial markets will provide a new growth opportunity for the Korean financial service industry.
However, the increased capital inflows and outflows from China will affect the domestic financial instability. Moreover, Chinese economic downturn as it happened can be quickly spread to the domestic real economy and amplify the negative impact by deteriorating the risk for the portfolio invested in China.
From the discussions above, we can drive the following policy implications. First, Considering that the renminbi internationalization is closely related to the financial market opening and greater trade and financial linkage with China, we should carefully monitor Chinese financial market and macro economy.
Second, the regional monetary and exchange rate coordination should be strengthened further. Because the Chinese macroeconomic policy change will have a greater impact on the regional finance and economy through the construction of yuan bloc, the regular and effective discussions among the policy makers in Korea, China and Japan are needed. In addition, Korea should consider its own currency internationalization.
Third, we have to utilize the revitalization of investment to China. Because the yuan-denominated financial products provide higher yields, public pension and private financial institutions should considering greater weights to Chinese market with necessary risk management. In addition, increasing the share of Chinese yuan in the foreign exchange reserves should be worth consideration in the long run.
Lastly, the yuan trading in the Korean financial market should be expanded. For this purpose, the supply base for renminbi liquidity should be enlarged by inducing the yuan settlement for Korea-China trade. However, as it takes time to for exporting companies to change their invoicing currency, the effort from the financial sectors to raise the demand for yuan should be preceded.