Why has policy turned to promote the international use of this currency? One interpretation, pursued here, is that internationalising the renminbi is a strategy to share the specific risk imbedded in China’s international balance sheet — namely, a large and rapidly increasing foreign exchange exposure. This exposure derives from the combination of China’s openness to direct investment from the rest of the world, its current account surpluses and the renminbi’s lack of internationalisation.

Like many advanced economies, China has a short position in its own currency and a long position in other currencies. But because of large direct investment in China and a substantial net foreign assets position, China’s net long position in foreign currencies is particularly large. The medium-term strategy of denominating some of China’s external claims in renminbi would help normalise this skewed position. This would effectively amount to ‘renminbising’ China’s international assets.

Internationalisation happens when non-residents of China use the renminbi to lend or to borrow. The renminbisation of China’s foreign claims requires that non-residents borrow in renminbi from residents. The subsequent sharing of the foreign exchange risk currently imbedded in China’s international balance sheet is a key motive for the broader process of internationalising the renminbi.

Conceivably, over the medium term, something like one-third of China’s non-reserve holdings of securities might come to be RMB-denominated. In this scenario, China’s sovereign wealth fund, pension funds and insurance companies could, to a significant extent, diversify away from Chinese credit risk, by buying RMB-denominated securities issued by non-Chinese firms, banks and sovereigns, without taking on foreign currency risk.

In addition to the private holding of bonds issued by non-residents in domestic currency, China could lessen its aggregate exchange-rate risk by denominating more of its official external claims in renminbi.

But while denominating and settling trade in domestic currency might encourage greater international use of the renminbi over the medium term, it is unlikely to directly spread China’s foreign exchange risk to the rest of the world in any significant way. Taking Japan as an example, 36.7 per cent of Japanese exports were yen-denominated in 2002, compared with 25.5 per cent on the import side. For China to accumulate substantial net trade claims on the rest of the world, an even larger asymmetry between exports and imports would be required, and this is not likely.

Yet the invoicing of trade in renminbi could still play a supporting role by encouraging the rest of the world to issue bonds and take on RMB-denominated official debt. This would encourage a global sharing of the foreign exchange risk in China’s international balance sheet.

In an apparent departure from its previous hesitancy and go-slow stance, the Chinese government has, since late 2008, proactively rolled out a number of measures aimed at increasing the international use of the renminbi. For example, the People’s Bank of China (PBOC) has signed bilateral renminbi currency-swap agreements with eight central banks, totalling more than RMB800 billion (US$126 billion). Such agreements permit swaps between the renminbi and the counterparty’s local currency for a maturity of up to three years, which is extendable. The PBC reports that, so far, RMB30 billion (US$5 billion) of these RMB800 billion swap agreements have been activated.

For these initiatives to build momentum, borrowers in the rest of the world will have to be convinced that borrowing in renminbi is not subject to a risk of rapid appreciation against other currencies. If the renminbi is perceived to be severely undervalued and subject to a prospective sharp appreciation, firms or sovereigns outside China would be unwilling to hold RMB-denominated liabilities.

There are both academic and policy studies that suggest the renminbi is substantially undervalued. Indeed, the 2010 IMF Article IV Consultation Staff Report posits that the renminbi ‘remains substantially below the level that is consistent with medium-term fundamentals’ (emphasis added). But the Chinese authorities offered alternative interpretations of the evidence that the report used to draw the undervaluation assessment. The report’s assessment was also not agreed to by several of the IMF Executive Board’s directors.

In considering the likelihood of rapid appreciation, it is crucial to remember that, in the economic arena, the Chinese authorities are perceived to follow a gradualist approach and to focus on economic stability. A massive renminbi revaluation poses the risk of serious disruption to China’s domestic economy and its extensive production and trade networks with other Asian economies. If the recent experience of gradualism is given weight, the prospect of a substantial revaluation of the renminbi becomes less likely, and should not impede the currency’s internationalisation.

Full internationalisation will ultimately require a thoroughly open capital account. The steps that China is taking should thus be seen as permitting internationalisation to begin within capital controls and, so far, this is mostly occurring in the offshore RMB-denominated market based in Hong Kong. Lifting the remaining capital controls to allow the renminbi’s full internationalisation remains a policy for another day.

Yin-Wong Cheung is Professor of Economics at the University of California, Santa Cruz. Guonan Ma is Senior Economist at the Representative Office for Asia and the Pacific, the Bank for International Settlements. Robert N. McCauley is Senior Adviser to the head of the Monetary and Economic Department, the Bank for International Settlements, Switzerland. Their research was presented at China Update 2011. The annual China Update conference is hosted by the China Economy Program, in collaboration with the East Asia Forum, at the ANU in July. This article is a digest of Cheung, Ma and McCauley’s chapter, ‘Why Does China Attempt to Internationalise the Renminbi?’ in Jane Golley and Ligang Song (eds), Rising China: Global Challenges and Opportunities (ANU E Press, 2011), available in pdf here. This book is the latest publication in the China Update Book Series, launched at the China Update conference every year. The views expressed here are those of the authors and do not necessarily reflect those of the BIS.