Author: Takatoshi Ito, University of Tokyo
It is almost certain that the 21st century is the Asian century in terms of real side of the economy — growth, trade, consumption, and investment. What is not certain is how Asia will integrate financially and what will happen to Asian currencies.
When the West feared the rise of the Japanese economy in the 1980s, some predicted that the yen would become an international reserve currency. But the Japanese government did not push internationalisation of the yen until it was too late, and when the bubble burst the Japanese economy weakened and the country entered a period of long stagnation. Now, the question is whether the Chinese renminbi (RMB) could become the default international in Asia.
The Asian currency crisis of 1997–98 made countries realise that what is important is not fixing their currencies to the US dollar but ensuring that they are not too volatile. Floating currencies became necessary as capital markets were opened, which in turn was essential to secure the inflow of foreign direct investment (FDI). On the other hand, a completely free currency float was thought to be undesirable because volatile currency movements would harm exports.
In the aftermath of the Asian currency crisis, Asian countries intensified their financial integration and cooperation to make the region better able to withstand internal and external shocks.
First, more policymakers were interested in the ‘basket currency’ arrangement because it seemed to provide a balance between flexibility and stability. Many were attracted to the idea of keeping Asian currencies jointly floating against the US dollar and the euro, but loosely binding them to each other at the same time to ensure stability. Asian governments even looked to the Exchange Rate Mechanism, an arrangement that led to the creation of the euro, as a model for the region. But critics emphasised that Asia relied on exports to the United States and Europe, so stability against the US dollar and the euro could not be sacrificed.
Another difficulty was the lack of political will. There was academic support for the creation of an Asian Monetary Unit (AMU) so that currencies would not deviate too much from the weighted average in the region. But such a concept required mutual commitment, and the idea did not gain political traction. This kind of arrangement continues to attract recognition. The Research Institute of Economy, Trade and Industry (RIETI, a Japanese government-sponsored research institute) still publishes AMUs for reference daily, and the figures show Asian currencies converging around the central value of AMU in the medium run. But the recent eurozone sovereign debt crisis, which partly stems from Europe’s adoption of a single currency not backed by a fiscal and banking union, dampened any remaining enthusiasm towards a more unified exchange rate arrangement in Asia.
Second, many ASEAN+3 countries saw reserve pooling as the most attractive form of financial cooperation after the Asian crisis. In particular, crisis-hit countries like Thailand, Indonesia, Malaysia and Korea thought reserve pooling could offer a safety net. Thailand’s rescue by the IMF, Japan and other Asian countries in August 1997 was a model, however imperfect, for future reserve pooling arrangements. While soon after that rescue a proposal for regional reserve pooling — dubbed the Asian Monetary Fund — was shot down by the IMF, the United States and China, leaders continued to push towards a regional mechanism. In May 2000 ASEAN finance ministers agreed on the Chiang Mai Initiative (CMI), a network of bilateral swaps. The size of CMI grew in several stages and eventually evolved into the Chiang Mai Initiative Multilateralization agreement (CMIM) in 2010, which sets up a self-managed reserve pooling system.
The environment has changed since the IMF opposed an Asian Monetary Fund in 1997. The recent eurozone crisis produced a regional liquidity assistance mechanism, the European Financial Stability Facility, as a temporary arrangement. Later, Europe created a permanent body, the European Stability Mechanism, to ensure financial stability, which effectively allows for regional reserve pooling, just as the Asian Monetary Fund would have done. Having seen this body at work in Europe, the IMF would surely not oppose the transformation of CMIM into a genuine reserve pooling system with a secretariat at the ASEAN+3 Macroeconomic Research Office (AMRO).
But while these regional efforts to rationalise currency arrangements and create reserve pooling systems are encouraging, they leave an opening for China. And the Chinese effort to internationalise the RMB is gaining momentum. It remains to be seen whether its successful internationalisation will replace AMF and CMIM partially, if not completely.
The Chinese government started promoting the internationalisation of the RMB in 2009 — telling Chinese companies that they should invoice exports and imports and settle contracts in RMB, if possible. There are difficulties, however, because if the trading partners of Chinese companies agree to invoice and settle with Chinese currency they have to bear the currency risk and hold RMB for trade finance. Foreign companies will be reluctant to do so unless the RMB becomes a fully convertible currency; that is, a currency with no restriction of any type, current or capital, on foreign exchange transactions.
In the area of reserve currency, the People’s Bank of China (PBOC) has started to implement currency swap arrangements with other central banks. First, the Chinese government allows RMB-denominated bonds to be issued and for them to be owned by other monetary authorities as foreign reserves; and, second, it allows a swap arrangement for contingency. The Japanese government became the first advanced country to agree to hold RMB bonds. If this movement becomes widespread, it will increase the share of RMB bonds in the pool of global reserve assets. On the other hand RMB – local currency swap arrangements may be used as a safety net, just as swap arrangements between the Federal Reserve Bank and other central banks were used after the collapse of Lehman Brothers in 2008–09.
The problem, again, is that RMB is not a fully convertible currency. Those countries that receive RMB would not be able to use the currency to pay for liabilities owed to countries other than China. But there seem to be other motivations at play. China’s official reasons for creating an RMB-centered swap arrangement include promoting trade and investment. If importers in other countries cannot obtain RMB to pay for what they buy, the swap between the central banks can be activated to finance trade. Companies wishing to invest in China can thereby obtain RMB to pay for their investment. So the swap arrangement can be used to supplement the Chinese government’s push for RMB invoicing and settlement.
The internationalisation of the RMB, if fully implemented with capital account liberalisation, has the potential to unite (most of) Asia as an RMB bloc. Trade invoicing, settlement and bond issues would all take place in RMB within the bloc. Countries would hold RMB assets as a part of their foreign reserves, and when a country falls into a liquidity crisis, the Chinese government would provide cash in RMB, either with or without IMF help. It may take several decades to get to that stage, but there is a clear trend toward it.
Takatoshi Ito is Professor of Economics and Dean of the Graduate School of Public Policy, University of Tokyo.