Since the US subprime mortgage crisis, the excessive volatility of the dollar exchange rate has greatly impacted global economy. Some emerging market countries hope to reform the international financial system dominated by the dollar and advance diversification of reserve currency, jointly upholding the stability of the international currency system.

It is under such an international background that RMB internationalization is widely discussed. It is a question worthy of thinking about how to push forward the implementation of tactics and policies along with scientific strategic layout.

RMB internationalization can be earliest traced back to the beginning of the 1990s when the RMB was used in neighboring countries and regions as settlement currency amid the opening-up of China’s economy.

The issue of RMB internationalization started to interest people and some scholars also began to pay close attention to it. The exchange rate of the RMB was unified in the reform of China’s foreign exchange system in 1994, which made the RMB’s free exchange become an important issue. Free exchange of the RMB is the precondition for realizing its internationalization. Back then markets were optimistic about the RMB’s free exchange and its internationalization. However, the expectation was interrupted by the Southeast Asian financial crisis from 1997 to 1998, which was mainly caused by the opening-up of capital account and the US dollar peg in Southeast Asian countries. People thereafter began to be cautious about the RMB.

After the international financial crisis in 2008, the US adopted its quantitative easing monetary policy. Countries with more foreign exchange reserves suffered big losses due to the depreciation of US dollar, and they strongly called for the reform of the international monetary system.

In this context, RMB internationalization sparked new debate and China also attached great importance to the strategy of the RMB “going global.”

Since 2008, China has carried out bilateral currency swap with many countries. In 2009, China began pilot projects for the use of the RMB in cross-border trade settlement. In June 2010, trials for that use of the RMB were expanded. Meanwhile, China actively pushed forward the development of Hong Kong RMB offshore financial markets, making it a RMB fund pool of offshore markets.

The two financial crises have deeply affected the process of RMB internationalization and the opening-up of capital account. They have also prompted people to re-examine the opportunity, routes and possible risks of RMB internationalization and the opening-up of capital account.

Amid rapid growth of the Chinese economy, China’s foreign exchange reserve reached $3.99 trillion by the end of June 2014. Promising financial markets and financial system reforms have laid a solid economic base for RMB internationalization. In addition, the international financial crisis and European sovereign debt crisis have also revealed problems of the dollar and euro as the main international reserve currency.

RMB internationalization actually includes two routes and two reserve pools. One route is the RMB “going global.” It includes ways such as trade, investment and capital flow, which enable the RMB to gradually become a settlement currency of trade, investment and financial transactions. The other is RMB backflow, which means making the RMB flow back from foreign economies through trade and capital projects. One reserve pool means that the RMB is becoming an exchange reserve in other countries. The other means that domestic open financial markets need to absorb RMB funds flowing back from abroad, forming an effective circulation of RMB funds at home and abroad.

Currently, RMB internationalization mainly depends on the construction of the above two routes. We should focus on pushing forward financial innovation and reform and continue to perfect currency swap, cross-border trade and the business of Hong Kong offshore financial markets. For example, implementation of the Shanghai-Hong Kong Stock Connect on April 10, 2014, has been beneficial to both the RMB “going global” and funds backflow. Additionally, offshore RMB markets should be established based on construction of the Shanghai and Shenzhen Qianhai free-trade zones.

The construction of the two reserve pools should also be taken into consideration. Whether other countries will treat the RMB as reserve assets depend on two aspects. One is China’s comprehensive economic strength which safeguards international credit of the RMB. The other is the full play of RMB functions, including the stability of currency value, convenience of transactions and yield rate of investment. This determines the degree of international demand for RMB assets.

In the process of RMB internationalization, we should also pay attention to guarding against financial risks. The opening-up of capital account, market reforms of exchange rate and interest rate should coordinate well with economic development and financial market construction to push forward RMB internationalization in the smooth operation of macro economy.

The author is an associate professor at the School of Economics at Fudan University.

The Chinese link: http://sscp.cssn.cn/xkpd/pl_20172/201409/t20140912_1324799.html

Translated by Yu Hui
Revised by Tom Fearon