Currency internationalisation: an overview Peter B Kenen1 Introduction An international currency is one that is used and held beyond the borders of the issuing country, not merely for transactions with that country’s residents, but also, and importantly, for transactions between non-residents. In other words, an international currency is one that is used instead of the national currencies of the parties directly involved in an international transaction, whether the transaction in question involves a purchase of goods, services or financial assets. It is important in this context to distinguish between a country that is host to an international financial centre and one that has an international currency. Singapore is a major international financial centre: banks located there, including the affiliates of foreign banks, conduct international business for their clients and themselves, including currency trading. In fact, in terms of the volume of currency trading, Singapore ranked fifth among all countries in the most recent BIS Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity; its total foreign exchange turnover was exceeded only by those of the United Kingdom, the United States, Switzerland and Japan (BIS (2008)). For many years, however, the government of Singapore strongly discouraged use of the Singapore dollar as an international currency – one in which foreign entities may issue or trade securities. Dimensions of internationalisation An international currency is one that performs some if not all of several tasks. Consider, first, the invoicing of merchandise trade. Although some countries invoice large fractions of their exports in their own national currencies, many others do not. In 2007, for example, some 77% of US exports to Japan were invoiced in US dollars, but 72% of Asian exports to Japan were also invoiced in dollars, not in the Asian exporters’ currencies, with almost all of the rest being invoiced in yen. Moreover, in that same year, 35% of EU exports to Japan were invoiced in euros, but 48% were invoiced in yen. Turning to Japan’s exports, we find that 40% of its exports to Asian countries were invoiced in yen, with the bulk of the rest being invoiced in dollars. But the yen is far less heavily used in the invoicing of Japanese exports to the United States, where the dollar dominates, and it is used much less than the euro in invoicing Japanese exports to the European Union, where the euro is more heavily used. These numbers have been fairly stable for the last few years, save for the share of the euro in the invoicing of Japanese imports from the member countries of the European Union, which rose sharply in 2001, soon after the introduction of the single currency (though not at 2 the expense of the yen, the dollar or the pound sterling). 1 Walker Professor of Economics and International Finance Emeritus, Princeton University. 2 See Papaioannou and Portes (2008), Table 5. Unfortunately, the table does not indicate which currencies lost shares to the euro in 2001. (They may perhaps have been invoiced in the currencies of individual euro area countries before the changeover to the euro, as the contracts involved may have been made before the changeover.) 1 There are, of course, exceptions to these patterns. Most importantly, exports of standardised commodities traded on organised exchanges are invoiced mainly in the currencies used on those exchanges, with petroleum being the most prominent example. Consider, next, the issuance of bonds and other securities. Some such instruments are denominated in the issuer’s currency, but many are denominated in the currency of the prospective buyer and, more importantly, many are issued in third countries’ currencies. In all three cases, however, they may be held and traded outside the issuer’s country. It is useful to distinguish three types of “international” securities.3 Some are issued on foreign markets by domestic or foreign entities and are called eurobonds, even when they are not denominated in euros. Soon after the introduction of the euro, however, the volume of euro- denominated issues came to exceed the volume of dollar issues. These two types of securities are listed in panels (2) and (3) of Table 1. Other bonds are issued domestically by foreign entities and may be designed to attract foreign buyers (eg by exempting them from withholding taxes on the interest payments). They are listed in panel (4) of Table 1. They are called yankee bonds when issued in the United States, samurai bonds when issued in Japan, kangaroo bonds when issued in Australia, and panda bonds when issued in China (of which the first two were issued in 2005 by the International Finance Corporation and the Asian Development Bank, subject to a subsequent understanding that the renminbi proceeds would have to remain in China). Table 1 How securities are issued (1) Issued by and to domestic entities and traded (2) Issued by domestic entities to foreign domestically and internationally entities and traded internationally (3) Issued by and to foreign entities and traded (4) Issued domestically by foreign entities and internationally traded domestically NB: The issues listed in panels (1) and (4) are denominated in the currency of the country in which they are issued. Those listed in panels (2) and (3) may be issued in the borrower’s currency if it is a widely traded currency but are typically issued in a major international currency such as the dollar or euro. The process of internationalisation A national currency can be regarded as an international currency if most of the following conditions hold. Note that the first condition is stated strongly, as a constraint on the government of the country under consideration, whereas the word “able” is used thereafter to convey a double meaning: that the government does not prohibit certain activities and that the relevant foreign parties, whether private or public, permit or facilitate the activity described. Note, further, that the conditions listed below need not be met simultaneously or abruptly. Some forms of internationalisation, such as the use of a country’s currency for invoicing trade, including trade between third countries, are likely to grow gradually with the increase in the volume of trade and the use of a country’s national currency in the invoicing of trade. 3 This taxonomy draws on McCauley (2006), who traces the internationalisation of the Australian dollar. 2 First, the government must remove all restrictions on the freedom of any entity, domestic or foreign, to buy or sell its country’s currency, whether in the spot or forward market. This condition clearly requires that the issuing country’s government remove any restrictions on foreign exchange trading by domestic and foreign entities, as well as any limitations on the freedom of foreign entities to hold the domestic currency and derivative instruments denominated in it. This condition, however, need not require that the government abolish all restrictions on the freedom of domestic entities to hold foreign currency assets or to incur foreign currency debts, nor does it bar the country’s financial regulators from limiting the long or short foreign currency positions of domestic financial institutions. Indeed, it may be necessary and appropriate for the regulators to keep a close watch on the size of the foreign currency positions of domestic banks. Second, domestic firms are able to invoice some, if not all, of their exports in their country’s currency, and foreign firms are likewise able to invoice their exports in that country’s currency, whether to the country itself or to third countries. The extent to which they can actually do that, however, may be limited by the sorts of goods they export, the market power of individual firms, and conventions prevailing internationally, such as the use of organised markets for trading petroleum and other primary commodities.4 Third, foreign firms, financial institutions, official institutions and individuals are able to hold the country’s currency and financial instruments denominated in it, in amounts that they deem useful and prudent. To the extent that foreign official institutions exercise this option on a significant scale, the country’s currency will function as a reserve currency, but very few currencies are capable of playing that role on a significant scale. At mid-2008, the countries that report to the International Monetary Fund the currency composition of their official reserves held 62.5% of those reserves in dollars, 27.0% in euros, 4.7% in pounds sterling, and 5.7% in Swiss francs, yen and other currencies.5 Fourth, foreign firms and financial institutions, including official institutions, are able to issue marketable instruments in the country’s currency. These may include both equity and debt instruments, not only in the country’s domestic markets but also in foreign markets, including, of course, the foreign firms’ own countries’ markets. The volume of foreign issuance in the domestic market may, of course, be regulated by the country’s government, as long as it does not discriminate against foreign issuers. If issued in the country’s domestic markets, those instruments must, of course, conform to domestic law, and disputes must then be adjudicated in that country’s domestic courts. If issued abroad, they must conform to the laws of the countries in which they are issued, and disputes must be adjudicated in those countries’ courts. Fifth, the issuing country’s own financial institutions and non-financial firms are able to issue on foreign markets instruments denominated in their country’s own currency. In that case, of 4 There is a large literature on this subject. See, for example, Bacchetta and van Wincoop (2005), Engel (2005) and Goldberg and Tille (2006). That literature, however, has focused mainly on optimal invoicing rather than actual practice, and has taken little account of the length of time that elapses between the placing of an export order and the payment date.