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June 1 is the first anniversary of direct trading between Chinese yuan， or renminbi， and Japanese yen. The anniversary comes at a time of strained ties between China and Japan， the world’s second and third largest economies， and inactive trading between the two currencies. But the yuan’s internationalization process has never once slowed， and the use of yuan in the international market continues to grow.
According to figures from the People’s Bank of China， the country’s central bank， China has reached currency swap agreements with more than 20 countries and regions， including South Korea， Malaysia， Singapore， New Zealand， Argentina and Turkey， with an aggregate swap value of 2 trillion yuan （$322 billion）. In 2012， 12 percent of China’s foreign trade volume was settled in yuan， while in 2010 the proportion was only 3 percent. The offshore yuan capital pool， which did not exist three years ago， stood at 900 billion yuan （$145 billion） at the end of 2012.
Remarkable progress， too， has been achieved in yuan’s exchange rate scheme. Since 2005， yuan has appreciated by 36 percent against the greenback. Slow appreciation and a comparatively stable exchange rate are conducive to advancing yuan’s internationalization process.
“Yuan’s internationalization is moving forward in a steady and orderly way，” said Yi Xianrong， a researcher with the Institute of Finance and Banking at the Chinese Academy of Social Sciences （CASS）.
According to Yi， internationalization will not， as some worry， challenge the status of U.S. dollar. Instead， the aim is for growing acceptance of China’s currency by the international community and for international settlement， investment and foreign exchange reserves.
Growing demand
Yuan began to be recognized internationally following the onslaught of the Asian Financial Crisis of 1997. With a stable exchange rate and the Chinese Government’s sense of responsibility during the crisis， the yuan was widely used among Southeast Asian countries.
After the 2008 global financial crisis， Southeast Asian countries， in order to avoid the negative impact of a fluctuating U.S. dollar， choose to settle bilateral trade with China in yuan， making the yuan the second most important currency in the region after the U.S. dollar.
To satisfy such demand， the central bank signed a $2-billion currency swap agreement with the Bank of Thailand in 2001. Since then， China signed such agreements with other countries in the region. With the rapid development of the Chinese economy， other neighboring countries began to use yuan. By the end of 2008， China had signed bilateral currency settlement agreements with nine neighboring countries， including Russia and Mongolia. The yuan has become a bona fide regional currency. In 2009， the Chinese Government allowed domestic companies to settle foreign trade in yuan because of a depreciating U.S. dollar.
On April 10 of this year， the yuan began direct trading with the Australian dollar， widely seen as a coup for the Chinese currency’s march toward more global acceptance. To promote direct currency trading， China’s central bank approved 34 foreign exchange market makers， such as Bank of China， Industrial and Commercial Bank of China as well as foreign banks including Citibank， Standard Chartered Bank， Deutsche Bank AG， BNP Paribas and Sumitomo Mitsui Banking Corp.
“There are no legal obstacles holding back the use of yuan in international trade settlement，” said Huang Ying， an analyst with Guodu Securities Co. Ltd.， which estimates that 136 countries are currently using yuan in settling international trade.
Demand for the yuan in Britain， France and Canada has increased remarkably in recent years. Their central banks are all preparing to sign currency swap agreements with China’s central bank. According to a report released by the Society for Worldwide Interbank Financial Telecommunication （SWIFT） on April 25， French companies had issued 7 billion yuan （$1.13 billion） of yuan bonds in 2011-12， and Paris had attracted 10 billion yuan （$1.61 billion） of yuan deposits， the second largest in Europe after London.
More offshore centers
Present yuan settlement in cross-border trade is carried out when the currency is not yet fully convertible. Therefore， China has to offer channels for yuan to flow out of the country for transactions abroad. This is why offshore yuan centers are set up.
At present， Hong Kong has become the most mature offshore yuan market， far ahead of others. Early in 2004， banks in Hong Kong began to accept yuan deposits. By the end of 2012， the balance of yuan deposits in Hong Kong had reached 603 billion yuan （$97.1 billion）.
The central bank supports the establishment of the offshore yuan market in Hong Kong， where dollar， euro and yen are also traded. The center in Hong Kong， a global financial yuan market， is a mature system from which China can learn during the process of yuan internationalization. This year is the 10th year for offshore yuan business since Hong Kong’s experiment with the currency began in 2004， and the offshore yuan business outside China has achieved noticeable progress.
In London， an old-line global offshore market， the first yuan bond was issued by Hong Kong and Shanghai Banking Corp. （HSBC） on April 18， 2012. Targeting investors from Britain and continental Europe， this bond has a planned scale of 1 billion yuan （$161 million）. The British Government set up work groups with the Hong Kong Monetary Authority and the City of London Corp. respectively in January and April 2012， aimed at establishing London as an important offshore yuan center.
In Singapore， the use of the yuan in Southeast Asian countries has greatly promoted the development of that offshore business. On February 8， China’s central bank designated the Singapore Branch of Industrial and Commercial Bank of China as a yuan settlement bank.
In August 2012， monetary authorities in Taiwan signed a memorandum of understanding on cross-Straits currency clearance and settlement. In February this year， the first 46 financial institutions began yuan business. According to the SWIFT yuan tracker released on March 27， Taiwan has moved up three posi- tions to fourth place （out of 136 countries and regions exchanging yuan payments） following a 120 percent increase of its yuan payments over six months， overtaking the United States and Australia and becoming the fifth largest center， behind Hong Kong， Britain， Singapore and France.
HSBC estimates that by 2014 the yuan will become one of the world’s three major trade settlement currencies， and the proportion of global yuan payments will double to reach 14 percent.
Besides Hong Kong， Taiwan， Singapore and London， the cities of Paris， Sydney， Tokyo and Dubai are also trying to become offshore yuan centers. Yang Tao， Director of Department of Financial Markets at the Institute of Finance and Banking under the CASS， said that although the international community is not yet sure when the yuan will become as significant as the U.S. dollar and euro， they have reached consensus that the yuan will become an international currency one day. On the other hand， traditional financial centers all hope to benefit from the yuan’s internationalization and vigor of the Chinese economy， which explains why international cities are competing to become offshore yuan markets. Yang thinks in the long term， there will be multiple offshore yuan markets. The development of offshore yuan markets is decided by two factors： the willingness of governments on both sides and mutual demand for economic and financial development of both parties.
“It is impossible for a single country to have such a big piece of the yuan internationalization pie，” said Yang， adding that multiple offshore yuan centers would prevent the pressure of an asset bubble and inflation in Hong Kong.
Second stage
The yuan must satisfy three conditions in order to become an international currency. First， a certain amount of yuan cash must be circulated in foreign countries， with a certain proportion of yuan-settled trade in overall international trade. Second， yuan-denominated financial products must become investment tools for major international financial institutions， including central banks. Third， most countries must accept yuan as their reserve currency.
The yuan has entered the second stage of internationalization， when its investment function has become a core issue.
“The settlement function is only one of the necessary conditions for internationalization of a currency. To be international， the yuan must realize its investment function，” said Yang.
On May 2， the central bank released guidelines on the implementation of the Renminbi Qualified Foreign Institutional Investor （RQFII） program， further regulating issues such as account opening and application procedures for international fund management companies to enter the inter-bank bond market. By the end of March 31 this year， 29 institutions had received RQFII qualifications， with a total quota of 70 billion yuan （$11.27 billion） being approved.
According to the central bank guidelines， overseas institutions under the RQFII pilot program should open three types of deposit accounts： RQFII basic deposit accounts， special deposit accounts for settlement at stock exchanges as well as special deposit accounts for settlement at inter-bank bond market.
Lu Zhengwei， chief economist of Industrial Bank Co. Ltd.， said that the RQFII program should be expanded to cover more overseas institutions， and the ultimate goal is to allow worldwide yuan funds to be invested in RQFII.
A long way to go
“To make the yuan a real global currency， China must allow for its full convertibility，” said Qu Hongbin， chief economist at HSBC China. At present， the yuan is freely convertible under the current account but not capital account. Qu thinks many conditions for full convertibility are ripe， including balanced payments under the current account， a more flexible exchange rate and the rapid use of yuan in overseas markets. In the meantime， reform of the financial system in the mainland is accelerating， and a modern corporate governance system has been improved. Chinese companies can freely convert yuan， and China has signed currency swap currency with more than 20 countries and regions. The time has come to gradually relax control of the capital account.
According to Qu， the reason why the Chinese Government hasn’t committed to a clear timetable to open the capital account is related to the value of the yuan and the stability of the Chinese market. Since the yuan is part of the capital markets， if the central bank has set a clear timetable， there will be risks of arbitrage activities in the money markets. “It is inappropriate for the central bank， the supervising authority， to give the market excessively high expectations. That will impose huge pressure to the market，” Qu said.
Xie Yonghai， chairman of BOCI-Prudential Asset Management Ltd.， delivered a speech for the School of Management at Fudan University on April 15， saying that the public should not be too optimistic about the yuan’s internationalization because it faces three major risks.
First， management risks. To make yuan an international currency， China must deal with the problems of capital flow， monetary policy and exchange rate policy. Second， backflow risks. If the amount of offshore yuan keeps growing， it may adversely impact the domestic yuan market when flowing back to China. Third， circulation risks， which need some contingency measures.
Xie said that based on these risks， yuan’s internationalization must be advanced under the prerequisite of China’s financial security， which is a long process.
Zhang Monan， associate researcher with the Economic Forecast Department of the State Information Center， said that currency internationalization is ultimately the result of market choices instead of being pushed forward by policies. The crucial point for yuan’s internationalization is whether the Chinese economy can maintain sound and sustainable growth in the next 20 years and whether China’s financial markets can be better developed. Under the present conditions of an underdeveloped domestic financial market， and the fact that interest rate and exchange rate schemes are not completely market-oriented， yuan internationalization should not be the government’s focus.
“Yuan internationalization cannot be achieved overnight， nor should it be hastened. Domestic financial and economic reform should be the focus，” Zhang said.
According to figures from the People’s Bank of China， the country’s central bank， China has reached currency swap agreements with more than 20 countries and regions， including South Korea， Malaysia， Singapore， New Zealand， Argentina and Turkey， with an aggregate swap value of 2 trillion yuan （$322 billion）. In 2012， 12 percent of China’s foreign trade volume was settled in yuan， while in 2010 the proportion was only 3 percent. The offshore yuan capital pool， which did not exist three years ago， stood at 900 billion yuan （$145 billion） at the end of 2012.
Remarkable progress， too， has been achieved in yuan’s exchange rate scheme. Since 2005， yuan has appreciated by 36 percent against the greenback. Slow appreciation and a comparatively stable exchange rate are conducive to advancing yuan’s internationalization process.
“Yuan’s internationalization is moving forward in a steady and orderly way，” said Yi Xianrong， a researcher with the Institute of Finance and Banking at the Chinese Academy of Social Sciences （CASS）.
According to Yi， internationalization will not， as some worry， challenge the status of U.S. dollar. Instead， the aim is for growing acceptance of China’s currency by the international community and for international settlement， investment and foreign exchange reserves.
Growing demand
Yuan began to be recognized internationally following the onslaught of the Asian Financial Crisis of 1997. With a stable exchange rate and the Chinese Government’s sense of responsibility during the crisis， the yuan was widely used among Southeast Asian countries.
After the 2008 global financial crisis， Southeast Asian countries， in order to avoid the negative impact of a fluctuating U.S. dollar， choose to settle bilateral trade with China in yuan， making the yuan the second most important currency in the region after the U.S. dollar.
To satisfy such demand， the central bank signed a $2-billion currency swap agreement with the Bank of Thailand in 2001. Since then， China signed such agreements with other countries in the region. With the rapid development of the Chinese economy， other neighboring countries began to use yuan. By the end of 2008， China had signed bilateral currency settlement agreements with nine neighboring countries， including Russia and Mongolia. The yuan has become a bona fide regional currency. In 2009， the Chinese Government allowed domestic companies to settle foreign trade in yuan because of a depreciating U.S. dollar.
On April 10 of this year， the yuan began direct trading with the Australian dollar， widely seen as a coup for the Chinese currency’s march toward more global acceptance. To promote direct currency trading， China’s central bank approved 34 foreign exchange market makers， such as Bank of China， Industrial and Commercial Bank of China as well as foreign banks including Citibank， Standard Chartered Bank， Deutsche Bank AG， BNP Paribas and Sumitomo Mitsui Banking Corp.
“There are no legal obstacles holding back the use of yuan in international trade settlement，” said Huang Ying， an analyst with Guodu Securities Co. Ltd.， which estimates that 136 countries are currently using yuan in settling international trade.
Demand for the yuan in Britain， France and Canada has increased remarkably in recent years. Their central banks are all preparing to sign currency swap agreements with China’s central bank. According to a report released by the Society for Worldwide Interbank Financial Telecommunication （SWIFT） on April 25， French companies had issued 7 billion yuan （$1.13 billion） of yuan bonds in 2011-12， and Paris had attracted 10 billion yuan （$1.61 billion） of yuan deposits， the second largest in Europe after London.
More offshore centers
Present yuan settlement in cross-border trade is carried out when the currency is not yet fully convertible. Therefore， China has to offer channels for yuan to flow out of the country for transactions abroad. This is why offshore yuan centers are set up.
At present， Hong Kong has become the most mature offshore yuan market， far ahead of others. Early in 2004， banks in Hong Kong began to accept yuan deposits. By the end of 2012， the balance of yuan deposits in Hong Kong had reached 603 billion yuan （$97.1 billion）.
The central bank supports the establishment of the offshore yuan market in Hong Kong， where dollar， euro and yen are also traded. The center in Hong Kong， a global financial yuan market， is a mature system from which China can learn during the process of yuan internationalization. This year is the 10th year for offshore yuan business since Hong Kong’s experiment with the currency began in 2004， and the offshore yuan business outside China has achieved noticeable progress.
In London， an old-line global offshore market， the first yuan bond was issued by Hong Kong and Shanghai Banking Corp. （HSBC） on April 18， 2012. Targeting investors from Britain and continental Europe， this bond has a planned scale of 1 billion yuan （$161 million）. The British Government set up work groups with the Hong Kong Monetary Authority and the City of London Corp. respectively in January and April 2012， aimed at establishing London as an important offshore yuan center.
In Singapore， the use of the yuan in Southeast Asian countries has greatly promoted the development of that offshore business. On February 8， China’s central bank designated the Singapore Branch of Industrial and Commercial Bank of China as a yuan settlement bank.
In August 2012， monetary authorities in Taiwan signed a memorandum of understanding on cross-Straits currency clearance and settlement. In February this year， the first 46 financial institutions began yuan business. According to the SWIFT yuan tracker released on March 27， Taiwan has moved up three posi- tions to fourth place （out of 136 countries and regions exchanging yuan payments） following a 120 percent increase of its yuan payments over six months， overtaking the United States and Australia and becoming the fifth largest center， behind Hong Kong， Britain， Singapore and France.
HSBC estimates that by 2014 the yuan will become one of the world’s three major trade settlement currencies， and the proportion of global yuan payments will double to reach 14 percent.
Besides Hong Kong， Taiwan， Singapore and London， the cities of Paris， Sydney， Tokyo and Dubai are also trying to become offshore yuan centers. Yang Tao， Director of Department of Financial Markets at the Institute of Finance and Banking under the CASS， said that although the international community is not yet sure when the yuan will become as significant as the U.S. dollar and euro， they have reached consensus that the yuan will become an international currency one day. On the other hand， traditional financial centers all hope to benefit from the yuan’s internationalization and vigor of the Chinese economy， which explains why international cities are competing to become offshore yuan markets. Yang thinks in the long term， there will be multiple offshore yuan markets. The development of offshore yuan markets is decided by two factors： the willingness of governments on both sides and mutual demand for economic and financial development of both parties.
“It is impossible for a single country to have such a big piece of the yuan internationalization pie，” said Yang， adding that multiple offshore yuan centers would prevent the pressure of an asset bubble and inflation in Hong Kong.
Second stage
The yuan must satisfy three conditions in order to become an international currency. First， a certain amount of yuan cash must be circulated in foreign countries， with a certain proportion of yuan-settled trade in overall international trade. Second， yuan-denominated financial products must become investment tools for major international financial institutions， including central banks. Third， most countries must accept yuan as their reserve currency.
The yuan has entered the second stage of internationalization， when its investment function has become a core issue.
“The settlement function is only one of the necessary conditions for internationalization of a currency. To be international， the yuan must realize its investment function，” said Yang.
On May 2， the central bank released guidelines on the implementation of the Renminbi Qualified Foreign Institutional Investor （RQFII） program， further regulating issues such as account opening and application procedures for international fund management companies to enter the inter-bank bond market. By the end of March 31 this year， 29 institutions had received RQFII qualifications， with a total quota of 70 billion yuan （$11.27 billion） being approved.
According to the central bank guidelines， overseas institutions under the RQFII pilot program should open three types of deposit accounts： RQFII basic deposit accounts， special deposit accounts for settlement at stock exchanges as well as special deposit accounts for settlement at inter-bank bond market.
Lu Zhengwei， chief economist of Industrial Bank Co. Ltd.， said that the RQFII program should be expanded to cover more overseas institutions， and the ultimate goal is to allow worldwide yuan funds to be invested in RQFII.
A long way to go
“To make the yuan a real global currency， China must allow for its full convertibility，” said Qu Hongbin， chief economist at HSBC China. At present， the yuan is freely convertible under the current account but not capital account. Qu thinks many conditions for full convertibility are ripe， including balanced payments under the current account， a more flexible exchange rate and the rapid use of yuan in overseas markets. In the meantime， reform of the financial system in the mainland is accelerating， and a modern corporate governance system has been improved. Chinese companies can freely convert yuan， and China has signed currency swap currency with more than 20 countries and regions. The time has come to gradually relax control of the capital account.
According to Qu， the reason why the Chinese Government hasn’t committed to a clear timetable to open the capital account is related to the value of the yuan and the stability of the Chinese market. Since the yuan is part of the capital markets， if the central bank has set a clear timetable， there will be risks of arbitrage activities in the money markets. “It is inappropriate for the central bank， the supervising authority， to give the market excessively high expectations. That will impose huge pressure to the market，” Qu said.
Xie Yonghai， chairman of BOCI-Prudential Asset Management Ltd.， delivered a speech for the School of Management at Fudan University on April 15， saying that the public should not be too optimistic about the yuan’s internationalization because it faces three major risks.
First， management risks. To make yuan an international currency， China must deal with the problems of capital flow， monetary policy and exchange rate policy. Second， backflow risks. If the amount of offshore yuan keeps growing， it may adversely impact the domestic yuan market when flowing back to China. Third， circulation risks， which need some contingency measures.
Xie said that based on these risks， yuan’s internationalization must be advanced under the prerequisite of China’s financial security， which is a long process.
Zhang Monan， associate researcher with the Economic Forecast Department of the State Information Center， said that currency internationalization is ultimately the result of market choices instead of being pushed forward by policies. The crucial point for yuan’s internationalization is whether the Chinese economy can maintain sound and sustainable growth in the next 20 years and whether China’s financial markets can be better developed. Under the present conditions of an underdeveloped domestic financial market， and the fact that interest rate and exchange rate schemes are not completely market-oriented， yuan internationalization should not be the government’s focus.
“Yuan internationalization cannot be achieved overnight， nor should it be hastened. Domestic financial and economic reform should be the focus，” Zhang said.