By the middle of 2015, almost 30 per cent of China’s trade was being settled in renminbi. Hong Kong banks were holding some 1 trillion RMB worth of yuan-denominated deposits and there was life in the dim sum bond market, with issuance running close to the equivalent of US$10 billion per month.
That year was also the year the International Monetary Fund (IMF) announced that the renminbi would become one of the currencies that underpin its own reserve asset, the special drawing right (SDR). Almost by definition, this step seemed to confer on the renminbi something like the status of a global reserve currency. So the renminbi seemed, to most observers, to be firmly on a path toward real international relevance.
Grounds for optimism have since proven to be decidedly fragile. These days, the share of China’s trade that is settled in renminbi is less than half of what it was in 2015. The stock of yuan-denominated deposits has fallen to just over 600 billion RMB and dim sum bond issuance late last year was down to US$1 billion per month.
It turns out that what most people saw as evidence of the renminbi’s internationalisation was simply evidence of something else: an accumulation of speculative positions built on the expectation that the renminbi was going to rise in value. As the renminbi weakened after mid-2015, so too did the market’s willingness to own it and use it.
This is hardly the mark of a global reserve currency. International investors want to own dollars or euros not just because they expect these currencies to strengthen, but because they offer legal security, ease of use and, critically, unrestricted convertibility into any other currency. And it is questions surrounding the renminbi’s full convertibility that are likely to stunt its growth as a global currency for the foreseeable future. Recent years have seen the Chinese government pivot away from the idea that the renminbi should be fully convertible.
Back in 2012, the ‘political report’ delivered at the 18th Chinese Communist Party Congress included a goal to ‘gradually realize capital account convertibility’. By 2017, officials had decided to drop any reference to capital account opening in the report to the 19th Party Congress. This change of heart was captured neatly in 2015 by then-People’s Bank of China governor Zhou Xiaochuan, who claimed that ‘the capital account convertibility that China is seeking to achieve is not based on the traditional concept of being fully or freely convertible’. Instead, China would adopt a concept of ‘managed convertibility’.
What ‘managed convertibility’ means, above all, is that the Chinese authorities assert a right to use their discretion to make decisions about which kinds of inflows and outflows are ‘good’ and which are ‘bad’. This assertion of the competence of policymakers seems to fit right in with what most people understand as a revival of the party-state under President Xi Jinping. The use of this discretion was on full display in late 2016 and early 2017, when Chinese authorities imposed heavy restrictions on the outflow of capital from China.
The effort that Chinese regulators have recently made to open up China’s securities markets won’t do much to change things. Even if the inclusion of Chinese bonds in the three main global indices — belonging to Bloomberg-Barclays, JP Morgan and FTSE Russell — brings in a few hundred billion dollars worth of portfolio inflows over the next couple of years, this doesn’t have any real bearing on the renminbi’s future as a global reserve currency.
The good news is that there is no law of nature that requires a reserve currency to be a fully convertible one. The Bretton Woods international monetary system that was set up at the end of World War II had capital controls at its very centre. The United Kingdom had capital controls until 1979 and it wasn’t until 1989 that France finally lifted the restrictions on its citizens’ ability to open bank accounts abroad.
Incidentally, it was a remnant of the Bretton Woods system that helped to build the case for the renminbi’s inclusion in the IMF’s SDR basket a few years ago. The IMF’s carefully phrased criterion was that it should be ‘freely usable’, which is certainly not the same thing as fully convertible.
What all this means is that it might be possible one day for China to have its cake and eat it — in other words, for the renminbi to be a truly global currency and yet for Beijing to retain a discretionary approach to managing the capital account. But it will probably take a Bretton Woods-like renegotiation of the international monetary system to get there. Don’t hold your breath.
None of this is to say that international use of the renminbi won’t rise in the future. It almost certainly will, especially in Asia where trade integration with China has already increased movement among the region’s currencies and the renminbi. But it also seems quite likely that China will remain attached to its preference for ‘discretion’. As long as that is the case, we will have to keep waiting for the emergence of China’s ‘great currency’.
David Lubin is a managing director and head of emerging markets economics at Citi and an associate fellow in global economy and finance at Chatham House.
A version of this article was first published here by AsiaGlobal Online.