Could the renminbi become an international reserve currency?

by Michael Liu and Fariborz Moshirian

The IGF has completed a research work on the internationalisation of the renminbi. This will be published soon in the Journal of Financial Perspectives.

The research work highlights the need for additional reserve currencies in order to increase international liquidity to support world economic growth. In light of this, the objective of the research work was to investigate the capacity of the Chinese renminbi to become an additional international reserve currency. To do this, we undertook a structural analysis of China’s renminbi to examine the presence of structural factors commentators identify as essential to an international currency. The research showed that while China’s large economic size (second only to the United States) meets one of the prerequisites for an international currency, it lacks other necessary structural features, which undermines demand for the renminbi. There are legal and political risks perceived with investment in Chinese assets. Its financial markets are still nascent offering relatively few (in both volume and variety) financial products to invest in. And its capital account is not fully open. Nor is it ready to be open. China’s domestic banking system is perceived to be weak. This raises risks of capital flight were the capital account to be liberalised. China’s financial system is less developed. This raises macrofinancial risks arising from the volatility of international financial flows into an economy with an open capital account and a less developed financial market. Further, China currently has a managed floating exchange rate. This raises further financial risks were the capital account to be liberalised. These structural factors hinder and deter increased foreign demand for the renminbi. Policymakers must address these factors before the renminbi will become an international currency.