E CHENGREEN I BARRY EICHENGREEN and MAsAHIRo KAwAI K RENMINBI A I tNtERNa IoNalIzatIoN w EdItoRs A I eet the next global currency: the Chinese renminbi, or the “redback.” Following the global financial crisis of 2008, one of the People’s Republic of China’s major monetary policy objectives is the internationalization of the renminbi—that is, to create an international role for its currency akin to the international role currently played Mby the U.s. dollar. Renminbi internationalization is a hot topic, for good reason. It is, essentially, a window onto the Chinese government’s aspirations and the larger process of economic and financial transformation. Making the renminbi a global currency requires rebalancing the Chinese economy, developing the country’s financial markets and opening them to the rest of the world, and moving to a more flexible exchange rate. In other words, RENMINBI the internationalization of the renminbi is a monetary and financial issue with much R NMINBI broader supra-monetary and financial implications. I t RN N I tNtERNa IoNalIzatIoN Eichengreen, Kawai, and their colleagues here offer a new perspective on the larger t E issues of economic, financial, and institutional change in what will eventually be the E world’s largest economy. Achievements, Prospects, and Challenges Contributors are Yin-Wong Cheung, City University of Hong Kong; Menzie Chinn, a University of Wisconsin; Benjamin Cohen, University of California, Santa Barbara; I Prince Christian Cruz, Asian Development Bank; Fan Gang, National Economic Research o Institute; Yuning Gao, Tsinghua University; Yiping Huang, Peking University; Hiro Ito, N Portland State University; Victor Pontines, Asian Development Bank Institute; Eswar a l Prasad, Cornell University; Changyong Rhee, Asian Development Bank (former); lei lei I z song, Asian Development Bank; lea sumulong, Asian Development Bank; Kunyu tao, at Central University of Finance and Economics; daili Wang, Peking University; Yu Yongding, I Chinese Academy of Social Sciences; and liqing zhang, Central University of Finance o and Economics. N BARRY EICHENGREEN is George C. Pardee and Helen N. Pardee Professor of Economics and Political science at the University of California, Berkeley. His books include Hall of Mirrors: The Great Depression, the Great Recession, and the Uses—and Misuses—of History (oxford 2013). MAsAHIRo KAwAI is Project Professor at the Graduate school of Public Policy, University of tokyo and formerly dean of the asian development Bank Institute. His recent coedited books include Reform of the International Monetary System: An Asian Perspective (springer 2014). BRo ING o A Brookings Institution Press Asian Development Bank Institute DBI K washington, D.C. Tokyo www.brookings.edu/press www.adbi.org s Co d VER EsIGN BY sEsE-PaUl dEsIGN BP_ADBI_Eichengreen_SCDec11final_2014.indd 1 12/11/14 4:04 PM 00-2611-1 FM:Layout 2 2/5/15 11:41 AM Page i Renminbi Internationalization 00-2611-1 FM:Layout 2 2/5/15 11:41 AM Page ii 00-2611-1 FM:Layout 2 2/5/15 11:41 AM Page iii Renminbi Internationalization Achievements, Prospects, and Challenges barry eichengreen masahiro kawai editors asian development bank institute Tokyo brookings institution press Washington, D.C. 00-2611-1 FM:Layout 2 2/5/15 11:41 AM Page iv Copyright © 2015 ASIAN DEVELOPMENT BANK INSTITUTE THE BROOKINGS INSTITUTION ASIAN DEVELOPMENT BANK INSTITUTE Kasumigaseki Building 8F, 3-2-5 Kasumigaseki, Chiyoda-ku Tokyo 100-6008 Japan www.adbi.org THE BROOKINGS INSTITUTION 1775 Massachusetts Avenue, N.W., Washington, DC 20036 www.brookings.edu All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means without permission in writing from the Brookings Institution Press, except in the case of brief quotations embodied in news articles, critical articles, or reviews. Note: The Asian Development Bank recognizes China by the name People’s Republic of China Library of Congress Cataloging-in-Publication data is available ISBN 978-0-8157-2611-1 9 8 7 6 5 4 3 2 1 Printed on acid-free paper Typeset in Adobe Garamond Composition by R. Lynn Rivenbark Macon, Georgia 00-2611-1 FM:Layout 2 2/5/15 11:41 AM Page v Contents Foreword vii Naoyuki Yoshino Preface ix 1 Introduction and Overview 1 Barry Eichengreen and Masahiro Kawai Part I. The Context 2 Will History Repeat Itself? Lessons for the Yuan 27 Benjamin J. Cohen 3 How Far Can Renminbi Internationalization Go? 53 Yu Yongding Part II. The Implications 4 Global Ramifications of the Renminbi’s Ascendance 85 Eswar Prasad v 00-2611-1 FM:Layout 2 2/5/15 11:41 AM Page vi vi contents 5 The Rise of the Redback: Evaluating the Prospects for Renminbi Use in Invoicing 111 Hiro Ito and Menzie Chinn 6 The Renminbi and Exchange Rate Regimes in East Asia 159 Masahiro Kawai and Victor Pontines Part III. The Process 7 The Role of Offshore Financial Centers in the Process of Renminbi Internationalization 207 Yin-Wong Cheung 8 Regional Settlement Infrastructure and Currency Internationalization: The Case of Asia and the Renminbi 236 Changyong Rhee and Lea Sumulong 9 Are the People’s Republic of China Financial Markets Deep and Liquid Enough for Renminbi Internationalization? 272 Prince Christian Cruz, Yuning Gao, and Lei Lei Song Part IV. The View from the People’s Republic of China 10 Paths to a Reserve Currency: Renminbi Internationalization and Its Implications 311 Yiping Huang, Daili Wang, and Fan Gang 11 The Benefits and Costs of Renminbi Internationalization 348 Liqing Zhang and Kunyu Tao Contributors 377 Index 379 00-2611-1 FM:Layout 2 2/5/15 11:41 AM Page vii Foreword naoyuki yoshino n view of the significant increase in the importance of the People’s Republic of IChina (PRC) in the global economy since the turn of the twenty-first century, it is not surprising that its domestic currency, the renminbi, is expected to play a major role in international trade and finance in the coming years. Indeed, the PRC has begun to promote the international use of the renminbi, as evidenced by the progress that has been made on renminbi trade settlements and on renminbi- denominated bond issuance in Hong Kong, China. The PRC is successfully sustaining a gradual approach to making the exchange rate regime more flexible and is also adopting a unique approach in striking out on its own path to a more open capital account. The PRC is moving gradually and systematically in the direction of greater capital account liberalization, testing out early reforms before proceeding with others. This involves the PRC and other enti- ties freely buying and selling the currency for trade-related purposes and for a lim- ited range of capital account and financial transactions, while the government attempts to continue to exercise control on presumably short-term investments through administrative and other measures. Over the medium term, however, the prospects of the renminbi’s taking on a greater international role are likely to be impeded by the weaknesses of the PRC’s financial system. Although the PRC’s financial markets have improved in some respects since 2000, there are still sig- nificant gaps, especially in terms of achieving a sufficiently large and liquid domes- tic bond market. vii 00-2611-1 FM:Layout 2 2/5/15 11:41 AM Page viii viii foreword Against this backdrop, Barry Eichengreen, George C. Pardee and Helen N. Pardee Professor of Economics and Political Science at the University of Califor- nia, Berkeley, and Masahiro Kawai, a former dean of the Asian Development Bank Institute (ADBI) and now project professor at the University of Tokyo, spear- headed this comprehensive study that brings together in one volume the range of important issues that are relevant to the renminbi’s growing international role: proactive policies to encourage this growth, and the functioning of markets in which this growth is occurring. In particular, the volume authors highlight the implications of the PRC’s liberalization strategy: in the next few years, the PRC will have a more open capital account than it does today, but with a number of administrative controls and regulations still in place. Absent the requisite reform of the PRC’s domestic financial market, the likelihood of the renminbi’s being used widely in international transactions—and thus its potential to be elevated to reserve-currency status, let alone to challenge the U.S. dollar’s status as the lead- ing reserve currency—is severely limited. The book’s authors also argue that the international community—especially the Asian region—has an interest in a smooth and successful internationalization of the renminbi. Renminbi internationalization can contribute to a rebalancing of the PRC economy, which benefits the world economy. It is also widely desirable that the PRC’s financial markets not be exposed to the risk of a crisis as the PRC moves ahead with its economic policy reforms. Taken together, the book’s authors convey their conviction that the interna- tional community should welcome the emergence of the PRC as a source of global liquidity. The recent global financial crisis led to a critical realization that the over- reliance by the international monetary system on a single, dominant reserve cur- rency poses an ever-present danger to the system’s stability. Eventually, the inter- nationalization of the renminbi will enable the PRC to be an alternative supplier of safe assets to the rest of the world in which firms, households, and central banks can park their savings, where they will later be available in case of a need for more liquid funding. It is the editors hope that this volume will contribute to a better and more informed discussion of the complex issues surrounding one of the major international and regional financial developments of our time.