Sukhdave Singh: Global RMB - challenges and implications
Keynote speech by Dr Sukhdave Singh, Deputy Governor of the Central Bank of Malaysia
(Bank Negara Malaysia), at the HSBC Forum: China Globalising: RMB Rising (Malaysia) -
"Global RMB: Challenges and Implications", Kuala Lumpur, 12 August 2014.
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It is an honour and pleasure to be here with you this morning to talk about what is likely to be
the most important development affecting the global monetary system since the introduction
of euro. Should the RMB become a global currency, it will transform the global financial
landscape. In fact, the RMB could potentially define this century, in the same manner that the
US dollar dominated the previous century.
In my remarks today, I would like to share some thoughts on the potential for the RMB to
achieve the status of a global currency. Where it to do so, what will the potential impact be
on the global monetary system? Finally, I will touch on the implications for Malaysia.
The world is ready, is China ready?
From where we stand today, the world is clearly ready for a global RMB. The question is
whether China itself is ready.
There is no question that the RMB would become an international currency. The only
question is how big of an international currency. Will the RMB's role in the international trade
and finance reflect the status of China as the second largest, and soon to be the largest,
economy in the world?
To be an international currency does not take much. You just need to lower the barriers and
allow for it to be traded outside your borders. The Malaysian ringgit was an international
currency before we de-internationalised it during the Asian Financial Crisis. At its peak, the
ringgit accounted for about 18% of Malaysia's trade settlements, which was significant given
the high trade orientation of the Malaysian economy. However, what we learnt from the crisis
in 1997 was that for our small open economy, the internationalisation of the ringgit was
inconsistent with maintaining macroeconomic and financial stability, and the benefits were
not commensurate with the risks. China is not a small economy but like Malaysia it is a
developing economy. Therefore, it is not immune to the types of vulnerabilities an
international currency and the accompanying open capital account can create in its immature
economy with its immature financial system.
The rapid momentum of the current RMB internationalisation reflects China's strong position
in global trade. However, it also reflects a safe phase of RMB internationalisation. It is
comparable to wading in shallow water, where you can see the bottom of the sea, anticipate
what hazards may lie on the sea floor, and therefore are able to walk rapidly. The real difficult
part is when you get into deeper waters, where the risks are less visible, the waves are
higher, the resistance of the water stronger. Progress can then be expected to be slower and
more cautious.
As the currency of a developing economy, the road to internationalisation of the RMB will
have many potholes, and it would be the skills and resilience of the policymakers in China
that will determine whether the RMB manages to navigate these hazards and travels far on
the road to internationalisation. After all, we can think of other more developed countries,
including another at one time second-largest economy, which upon reaching the threshold on
which China stands today, decided that the costs that come with having their currency
playing a big international role were something that they did not want to bear. For lack of
official support, these currencies consequently never achieved their full global potential.
Would the reality be different for China? Only time will tell. It is the case that the RMB will sail
more smoothly and speedily in international waters if its sails are filled by the strong winds of
robust Chinese economic fundamentals.
Five key pre-conditions to being a global currency
So allow me to look at some of the key fundamentals that I believe would support a
sustainable progress of the RMB towards being a major global currency.
Studying the history of global currencies such as the British pound and the US dollar
provides us some indication of the possible path of RMB internationalisation. Let me be
clear, this does not mean that I am implying that the RMB must necessarily follow the path of
other major global currencies. Nevertheless, such reflection does provide an opportunity for a
realistic assessment of the prospects and challenges that lie ahead for the RMB. There are
at least 5 key factors. Let me list them without going into the details.
• Currencies that rise to dominance are often of countries that are dominant in
global trade.
• Currencies often become internationalised because the country is a key global
exporter of capital.
• Every successful currency had official support.
• Currencies can only rise to international prominence when backed by liberalised
and developed markets.
• There needs to be confidence in the currency and the economy.
How does China fare against these signposts? I would say that it is three out of five. As far
as trade dominance is concerned, China surpassed the US economy as the largest goods
trading nation in 2013.
The internationalisation of the currency, despite its cautious nature, is certainly getting a lot
of official support - not just from Chinese policymakers but also from policymakers in other
countries.
As for confidence in the currency and the economy, there would not be so much enthusiasm
for RMB internationalisation were such confidence missing. The fact that countries are
queuing up to be able to trade RMB within their borders, or to gain access to China's
domestic financial markets, shows a strong desire on the part of these countries to
participate in what they see as an economy with a potential for continued strong growth.
There is a deep hunger internationally for Chinese consumers, Chinese exports, Chinese
assets and of course, the Chinese currency. While the USD was at one time supported by its
gold backing, the RMB today is backed by China's huge foreign exchange reserves.
Confidence in the currency is further enhanced by expectations of conditions in China
remaining supportive of a strong currency.
The main precondition on which China does not do well is in the stage of development and
readiness of its financial system and policy frameworks.
These challenges are not insurmountable but they are big enough to make Chinese
policymakers adopt a gradual and sequenced approach to RMB internationalisation. They
are big enough that premature liberalisation could create significant risks to macroeconomic
and financial stability. The challenge for Chinese policymakers is to develop the domestic
financial system to a level where integration with the global financial system would not lead
to significant vulnerabilities. Therefore, the state of the financial system will be a key
determinant of the extent to which policymakers are willing to liberalise and open their
system, and consequently, will also be a key determinant of the extent and pace of RMB
internationalisation. The global status of the RMB is closely linked to the global status of the
Chinese financial system. Ambitious reforms could expedite RMB internationalisation.
On the issue of being a global exporter of capital, China is certainly that. However, a large
part of these outflows have been official and they have not been in RMB. This in fact touches
at the heart of what is known as the Triffin Dilemma. China has been sending USDs abroad
because that is what it has been receiving through its current account surpluses and FDI
inflows. Sometime in the future, China may develop a structural current account deficit, but I
do not see that happening in the foreseeable future. Opening up the capital account and
domestic financial system to non-resident investors could lead to even more foreign currency
capital inflows. On both accounts, China will not only continue to export USD capital but
could find itself confronted by persistent appreciating pressure on its exchange rate due to
the high demand for RMB.
Promoting RMB for trade settlement will only go so far in resolving this. If more of China's
trade is settled in RMB, less USD will flow in, and China would need to intervene less and
would have less USD to send abroad. But the question remains, with more RMB flowing in
through the current and capital account, how do you get more RMB out of China in the first
place?
There are in fact numerous possibilities for China to create a significant pool of RMB liquidity
abroad without necessarily running a current account deficit. This include RMB outflows
through official aid, international loans by banks in China, foreign issuance of debt in Chinese
markets, direct investment abroad, inter-company loans, repatriation of corporate profits,
resident spending abroad and so on. Some of these are already happening. Offshore RMB
balances in Hong Kong, Chinese Taipei and Singapore for example rose almost 40%
between late 2013 and early 2014 to RMB1.4 trillion.
These numbers are indeed encouraging, except for one thing. When the RMB is abroad, it
gets homesick, terribly homesick. It yearns to return home to the land of its birth. When the
legal avenues for it to do so are limited, it desperately seeks other ways to do so. And as the
size of overseas RMB pool increases, the pressure of the homeward bound flows will also
increase. Will the Qualified Investor Schemes, RMB clearing banks and the eventual
introduction of the China International Payment System alleviate this situation of the offshore
RMB? Yes, it would, but not entirely.
In the current situation, despite the sharp increase in RMB related trade and investment
transactions, the data I have seen suggests that the use of RMB remains rather lopsided and
favours the flow of RMB into China rather than out of China. A significantly greater proportion
of China's exports were paid for in RMB, then its imports. Similarly, while 63% of the FDI into
China was in RMB, only 16% of the direct investment out of China was in RMB.
What all these lead us to is that a currency cannot be a true global currency on the basis of
current account convertibility alone. It needs to be convertible also on the capital account.
However, a significant opening of the capital account is the deep water in China's quest to
globalise the RMB. It is like the RMB sailing out of the calm waters of the harbour into the
choppy waters of the wide open seas. Having the support of the five fundamental factors I
have discussed will ensure that the RMB is better prepared to navigate those choppy waters.
To ensure sustainable RMB internationalisation would require patience, persistence and
careful thought - both on the part of Chinese policymakers as well as those outside China.
How an internationalised RMB could change the global landscape
Let me now move on to briefly delve on the implications of a global RMB on the global
monetary landscape.
In today's global monetary system, nobody can deny that there is a lack of choice when it
comes to global currencies. This situation is rather precarious. We saw during the Financial
Crisis in the Advanced Economies how financial markets globally seized up and the global
monetary system came to the brink of collapse. A more multipolar monetary system should
engender greater global financial stability. If global liquidity was represented by more
currencies, then the likelihood of any one currency being a determinant of global liquidity
would be significantly reduced. The observation of large surpluses of a currency, and that
currency nevertheless appreciating, is an anomaly created by a global system where there
are too few global currencies. By there not being enough choice, the whole world bears the
pain when the domestic policies of the few major currency economies become extreme and
inconsistent with the global role of their currencies.
Monetary policy in many major advanced economies is being conducted as if theirs are
closed economies with closed financial systems. The implication in terms of how monetary
policy is conducted is that it creates a false sense of confidence about the effectiveness of
extreme monetary policy with respect to the domestic economy and a failure to fully
appreciate the global implications. In an integrated global economy and financial systems,
the impact of policies leak out. Investors and savers earning lousy returns on their savings do
not simply throw up their hands and say "since I'm earning lousy returns I might as well
consume my savings or save less." No, they start looking for other means to preserve the
value of their savings, including venturing beyond their borders in search for better returns.
The outcome is a monetary policy that is less effective than what is envisioned by the
policymakers in the major economies and a significant policy headache for countries that are
on the receiving end of those capital inflows.
The rise of the RMB will not entirely solve that, but hopefully, it will lead to a world where the
global monetary system is less distorted, with less of the friction that we see now, and a
greater sharing of the burden and benefits of serving as the world's currency.
Malaysia and the global RMB
Finally, how would the globalisation of RMB affect Malaysia?
For Malaysia, there is no downside to the RMB becoming an international currency. China is
one of our largest trading partners and anything that facilitates the growth of trade and
investment flows between the two economies is good. We understand some of the policy
challenges China faces and is likely to face as it internationalises its currency. We
understand the need for it to adopt a gradual approach and providing itself the space to
address any vulnerability that may emerge as a consequence of internationalizing the RMB.
But, we also know that as China develops its financial markets and its policy frameworks,
greater openness would by synergetic in promoting the further development of its financial
system and its economy, and of course the international role of the RMB.
Policymakers in Malaysia are fully committed to strengthening our economic and financial
ties with China. As far as using RMB for international trade and investment is concerned, we
have worked to put the necessary infrastructure in place and continue to improve on it to
make it cheaper and more convenient. However, it is the private sector that must decide on
the economics of using the RMB for international payments and receipts. Institutions like
HSBC can play a very helpful role in educating their clients and the broader business
community in Malaysia on the possibilities of the RMB, as well as providing feedback to
policymakers on what more we can do to create a more conducive environment to allow
RMB trade to grow.
Conclusion
To conclude, ladies and gentlemen, the internationalisation of the RMB has gained
significant momentum over the last year or so. That is encouraging and it appropriately
reflects the growing role of China in the global economy. As I stated earlier, there is no doubt
that the RMB will be an international currency. The only question is how big of an
international currency. To answer that question, it is worth reminding ourselves that China is
internationalizing the RMB not because it believes that it is good for the world, but because it
believes that it is good for China. Therefore, whether the RMB internationalisation will be
able to maintain its momentum, or even accelerate, will depend very much on what happens
in China in the coming years. If the Chinese policymakers are successful in managing the
political, economic and financial trade-offs entailed in moving to a global currency, than the
21st century may indeed very well be the century of the global RMB.