China’s RMB Internationalization Strategy: Its Rationales, State of Play, Prospects and Implications Hyo-Sung Park August 2016 M-RCBG Associate Working Paper Series | No. 63 The views expressed in the M-RCBG Associate Working Paper Series are those of the author(s) and do not necessarily reflect those of the Mossavar-Rahmani Center for Business & Government or of Harvard University. The papers in this series have not undergone formal review and approval; they are presented to elicit feedback and to encourage debate on important public policy challenges. Copyright belongs to the author(s). Papers may be downloaded for personal use only. Mossavar-Rahmani Center for Business & Government Weil Hall | Harvard Kennedy School | www.hks.harvard.edu/mrcbg Work-in-Progress Report China’s RMB Internationalization Strategy: Its Rationales, State of Play, Prospects and Implications Hyo-Sung Park June 30, 2016 The author is currently Ambassador at Large at the Ministry of Foreign Affairs (MOFA), Seoul, Korea, and an Associate at the Harvard Kennedy School‘s Mossavar-Rahmani Center for Business and Government (M-RCBG) from March through June 2016. Ambassador Park served as Director-General for FTA Negotiations (2008-2009), Ambassador and Deputy Permanent Representative at the Korean Mission to the UN Secretariat and International Organizations in Geneva (2010-2014), and Ambassador to Romania (2014-2015). He led the Korean delegation for the Industry-Government-Academia Joint Study on the Korea-China FTA. He was Senior Fellow at the M-RCBG (2009-2010). Disclaimer: The views and opinions expressed in this paper are those of the author and do not necessarily reflect the official policy or position of the Korean Ministry of Foreign Affairs nor the views of the M-RCBG. Contents 1. Introduction……………………………………………….……………….1 2. Rationales for RMB Internationalization……..………………….………6 2.1 Trade Facilitation…………………………………….……………………....7 2.2 Taming the Inflation Monster…………………………………………..…...8 2.3 Response to the Fed’s Quantitative Easing (QE): Getting out of the “dollar trap” ………………………………………………………………………...12 2.4 Catalyst for the Reform of the International Monetary System …….…..14 2.5 Geo-strategic Considerations………………………………………………17 3. The RMB Internationalization Strategy and Key Implementation Efforts ……………………….…………………….………………………19 3.1. Pillar I: Promoting the Use of the RMB……………………….………….22 A. Facilitation of RMB Trade Settlements………………………….…….22 B. Financial Reforms and Capital Market Opening: “Crossing the River by Feeling the Stones”………………………………………………………..26 Launching RMB Banking Services……………..….…………….….….27 Liberalizing Bank Deposit and Lending Rates……………...………….29 Cultivating RMB Bond Markets……………….…….……………...…..31 Facilitating RMB Inflows and Outflows……………….………...……..38 Opening the Foreign Exchange Market …………….……………...….42 3.2. Pillar II: Building a Global RMB Financial Infrastructure and Networks ……………………………………….…………………..….……………45 A. Establishing an Infrastructure and Mechanisms for Facilitating Wider RMB Use ..………………………………………………………………45 Building a Global Network of RMB Trading and Clearing Centers....46 Starting Direct RMB Trading…………………………………..……...49 Expanding a Network of Bilateral Swap Arrangements(BSAs)…..…..51 Launching the China International Payment System(CIPS)…….…...55 B. Expanding FTA Networks………………………………………..….…56 C. Launching the One-Belt-One-Road (OBOR) Initiative…….………...59 3.3. Pillar III: Accelerating Momentum for the New IMS …………..….….. 63 A. Expanding a Regional Financial Structure…………………….……..64 The Chiang Mai Initiative (CMI)…………………………...…………..64 Chiang Mai Initiative Multilateralization (CMIM)….…………………65 B. Launching Development Banks …………………………….….….…..68 Asian Infrastructure Investment Bank (AIIB)…………………….…....68 BRICS New Development Bank…………………………….…………...73 Inter-SCO Development Bank…………………………………………..76 C. Inclusion of the RMB in the SDR Basket……………………………..78 4. Stocktaking of RMB Internationalization ………..…….………….…. 81 4.1. Performance in Global Trade Finance and RMB Trade Settlements ...…82 Emergence as the World‟s 2nd Most Used Currency in Trade Finance …82 Continued Expansion of Trade Settlements in RMB ……………………83 4.2. The RMB’s Rise as the World’s No. 5 Payments Currency ……………...85 4.3. Rapid Advancement in Global Foreign Exchange Markets ……………..86 4.4. The RMB’s Debut as a Reserve Asset ………………………………..……88 4.5. Emergence as the 3rd Weightiest Currency in the IMF SDR Basket ……90 5. RMB Internationalization and its Potential Impact on the Dollar ……94 5.1. The East Asian Dollar Standard versus the RMB Bloc in East Asia ….…94 5.2. China’s Dollar De-pegging………………………………………..……….. 99 5.3. China’s Dollar-deleverage …………………………………….…………. 101 The growing need to deal with China‟s foreign reserves ………..…. …104 The „Go Global‟ Strategy and Outbound Foreign Direct Investments ...107 Dollar-deleveraging…………………………………………...…………112 6. RMB Internationalization and the Future of the IMS ……….…….…115 6.1. The Dawning of a Global Multipolar Currency System ….…….……….115 6.2. Will the RMB Replace the Dollar? ….…….…..……………………….…120 6.3. The US Responses: Challenges and Opportunities …………………...…123 A. Taming the ‘Deficit Gorilla’ in the Room: Budget and Current Account Deficits …………………………………………………………………124 B. Expanding Economic and Trade Networks: Pro-active, Forward-looking Action Agenda ………………………………………………………….128 The Growing Importance of Trade for the US Economy …………….129 Dwindling US Market Share ……………………….……….…...…… 132 Why the US Should further strengthen its trade relations with Asia …133 What to do?.. ……………………….……….………………….………137 C. Attracting Foreign Investments ………..…………………………….138 The declining US share of world FDI stock ….……………………… 138 What benefits will inward FDIs bring for the U.S. economy and the dollar? …………………………………………………………………………..141 China‟s soaring outbound FDIs……………………………………….143 Growing and diversifying Chinese investments in the US ……….…...144 Promoting bilateral FDI flows between the US and China …………..148 7. Conclusion……………………………………………………………….…...150 Global Coordination: Emergence of the G-20 as the premier forum for international economic and financial governance…………………………....150 Constructive rebalancing of the relationship between the IMF and the G20 …152 Strengthening the Multilateral Trading System…………..………………… …153 Chimerica or Chimera………………………….…….………..………………...154 1. Introduction The international monetary system (IMS) is currently in flux because, as history has shown, reserve currencies come and go. The pound sterling ceded its position as the leading reserve currency to the US dollar in the mid-1920s,1 and since then, the greenback has reigned over the international monetary system. When the euro was finally launched on January 1st, 1999, it was considered an epoch-making event within the IMS. As Nobel Laureate in economics, Robert Mundell, expressed it: ―The introduction of the euro will challenge the status of the dollar and alter the power configuration of the system.‖2 Although the Euro was to become the currency of more than 300 million people in Europe, it remained an invisible currency, used only for accounting purposes, during the first three years of its existence, until euro cash was introduced on January 1st, 2002, thereby replacing the banknotes and coins of the Eurozone‘s national currencies.3 Central banks began to increase their euro holdings, which led some observers to wonder whether ―the euro could challenge the dollar‘s status as the world‘s top reserve currency.‖4 The euro‘s share in global foreign-exchange reserves started at 17.9 percent in 1999, hitting a peak of nearly 28 percent in the third quarter of 2009. The rather smooth sailing of the euro, however, hit a snag when the Eurozone‘s debt crisis erupted in 2010, causing the currency to lose some appeal. Euroscepticism gained traction. ―The crisis in Greece and the debt problems in Spain and Portugal have exposed the euro‘s inherent flaws,‖ argued Harvard economist, Martin Feldstein. The currency was ―bound to fail,‖ Feldstein continued, because unlike ―the United States able to operate with a single currency, despite major differences among its fifty states,‖ Europe has none of the ―three key economic conditions that allow the diverse US states to operate with a single currency: labor mobility, wage flexibility, and a central fiscal authority.‖5 Although the euro remains the second largest reserve currency, the Eurozone crisis and the ongoing global economic crisis caused the euro‘s share of total reserves to continue to go down. Its share decreased from 27.6% in 2009, before the outbreak of the Eurozone crisis, to 19.9% (compared with 64.1% for the dollar) in 2015. 1 Barry Eichengreen and Marc Flandreau, ―The Rise and Fall of the Dollar, or When did the Dollar Replace Sterling as the Leading Reserve Currency?‖ prepared for the conference in honor of Peter Temin, Cambridge, May 9, 2008, p. 21. 2 Robert A. Mundell and Armand Clesse, The Euro as a Stabilizer in the International Economic System (New York: Springer, 2012), p. 57. 3 European Central Bank, ―Use of the euro,‖ https://www.ecb.europa.eu/euro/intro/html/index.en.html 4 Ira Iosebashvili and Min Zeng, ―King Dollar Reaffirms Its Global Supremacy,‖ The Wall Street Journal, March 31, 2015, http://www.wsj.com/articles/dollar-share-of-global-foreign-exchange- reserves-rises-1427815826 5 Martin Feldstein, ―The Euro‘s Fundamental Flaws: The single currency was bound to fail,‖ SPRING 2010 THE INTERNATIONAL ECONOMY, pp. 11-12. 1 To complicate matters further for the euro,