Home »Articles and Letters » Articles » CPEC brings RMBs to Pakistan

The State Bank of Pakistan has recently allowed Pakistanis and Chinese public and private sector enterprises to use Chinese Yuan for bilateral trade and investment activities. China's Foreign Ministry spokesperson Geng Shuang while answering a question regarding this development had recently clarified that since the central banks of China and Pakistan signed a bilateral currency swap deal in 2011, the currency cooperation between the two countries has deepened.

"At present, various forms of trade and investment cooperation between China and Pakistan are developing in an in-depth manner. We encourage market players of the two countries to settle bilateral trade and investment in local currencies and welcome Pakistan's relevant measures," he said.

He further said that this move will help provide better financial conditions for China-Pakistan bilateral trade and investment cooperation and the building of the China-Pakistan Economic Corridor (CPEC).

Since the late 1990s, China has emerged as a major world power. Beijing's performance during the Asian financial crisis played a big part. As its neighboring countries' currencies took a dive in 1997 and 1998, China faced tremendous pressure to devalue the RMB. It refused to do so, and although Chinese exports suffered heavily, Beijing drew praise from around the world, affirming its self-perception as a "responsible great power." Then came the years after 2007, when China hosted the Olympics, sent its first astronauts to walk in space, and preserved the growth of its economy as the United States fell into its worst financial crisis in decades. Meanwhile joining the IMF's SDR basket may have involved financial risks, but it also promised an intangible reward in the form of international prestige. In late 2015, when the IMF finally approved the Chinese currency's entry into the SDR basket, it was warmly celebrated in China. For China's leaders and for the Chinese public, the news was a clear sign of China's rising international status.

Beijing's SDR policy has been more about affirming China's national identity than about advancing its material interests. Meanwhile, the jury is said to be still out on whether the Chinese renminbi (RMB) will displace the U.S. dollar in the foreseeable future. Many believe the RMB will meet the same fate as the yen which at its peak strength had attempted to displace the dollar but failed.

Saori N. Katada (Can China Internationalize the RMB? Published in Foreign Affairs on January 1, 2018) argues that challenging a hegemonic currency is not simple. According to Mr. Katada, for the RMB to eventually reign supreme, not only would the Chinese leadership, particularly the country's monetary authority, need the political will to prioritize the internationalization of its currency over concerns with domestic stability, it would also have to gain the support of the financial markets and other economic and political players.

"The recent history of how the Japanese yen tried and failed to become the dominant international currency provides a good illustration of the challenges. By the late 1980s, the world had started to see Japan's economic power and its currency, the yen, as a major competitor to the U.S. economic order. But Japan was not ready to take on the role of challenger; after the Asian financial crisis (1997-98), the Japanese government made serious efforts to internationalize yen, but its policies did not help in that regard."

In the late 2000s, concerns over dollar dominance in East Asia reemerged, this time in the context of the global financial crisis. This crisis is said to have spurred China's efforts to internationalize the RMB, already gradually underway since the early 2000s.

Clearly Japan did not react positively to China's economic acceleration. It appears Japan has been lukewarm toward RMB internationalization for the last several years. Japanese non-financial corporations, especially small and medium-sized firms, do not typically use the RMB to settle their trade with China despite the high volume of trade between the two countries. And although RMB's use in Japan's trade rose in 2015 yet Japanese financial institutions, especially globalized mega-banks, remain ambivalent. On the one hand, they see that RMB internationalization will expand their business opportunities overseas. Some, including economists from respected think tanks such as the Namura Research Institute and Japan Research Institute, even argue that doing so would revive Tokyo as a financial center and, by directly trading between the RMB and the yen, might also contribute to the internationalization of yen.

But the Japanese financial sector perhaps due to political reasons continues to emphasize on risks in the RMB business, supposed to be stemming from Japan's experience with China's highly politicized financial dealings. The collapse of China's Guangdong International Trust and Investment Corporation (GITIC) in 1999 and Dairen International Trust and Investment Corporation (DITIC) in 2000 are said to have forced Japanese banks to forgo most of their outstanding debts.

On the government side, enthusiasm about facilitating the use of RMB around Japan and in Asia is said to be muted since the early days of RMB internationalization, most likely because of the lack of bottom-up demand from Japan's private sector and a wealth of other priorities.

"In the early days of China's efforts to internationalize its currency, at a summit between the two countries' leaders, the Japanese government did set up a Japanese-Chinese agreement: 'Enhanced Cooperation for Financial Markets Development.' The agreement aimed to promote the use of the Japanese yen and RMB in cross-border transactions, including the direct exchange markets, and to support the development of yen- and RMB-based bond markets as well as yen- and RMB-denominated financial products. As a result of this agreement, Japan became the first country besides the United States to engage in direct RMB currency exchange with China. But the overall amount of direct currency trading between the two countries has thus far been limited". Again the reason seems to be political rather than economic.

"Five years after the initial burst of cooperation, on December 22, 2017, the monetary authorities of Japan and China finally approved allowing Japanese corporations to issue RMB-based bonds (so-called "Panda bonds") in China."

Nonetheless, as Mr. Katada says the Japanese government has still not signed on to any of the four important initiatives that the Chinese government has advanced to promote RMB internationalization.

"The first was the bilateral currency swap arrangement that the Chinese monetary authority extended to more than 30 countries around the world after the global financial crisis. Although the Japanese government was the first to conduct a currency swap with China under the CMI, it has not renewed the arrangement since it expired in September 2013.

"Second, Japan has yet to acquire RMB Qualified Foreign Institutional Investor (RQFII) status, which would allow Japanese institutions to invest in RMB-based assets in China. As of January 2017, institutional investors from 16 countries besides Hong Kong and Taiwan are registered, totaling RMB 529.6 billion (US$77.2 billion) worth of quota.

"The third initiative is related to the RMB payment settlement system. In 2014, China's offshore financial centers expanded beyond Hong Kong, Taiwan, and Singapore when China's central bank established deals with banks in several countries, including Australia, Canada, Germany, Malaysia, Thailand, and the United Kingdom. The memoranda of understanding afforded these banks direct access to China's National Advanced Payment System, which functions as an electronic inter-bank clearing and settlement system.

"Furthermore, to compete against the payment clearing and settlement service offered globally by SWIFT, China launched in October 2015 the Cross-Border Inter-Bank Payment System (also called the China International Payment System; CIPS), through which foreign banks can access RMB settlement directly. In both cases, no Japanese banks participated, restricting Tokyo's role in the RMB business.

"Finally, the Japanese government has thus far stayed out of the Asian Infrastructure Investment Bank (AIIB), which Chinese President Xi Jinping proposed in October 2013 and came into existence in January 2016 with a $100 billion funding base. Though it is still unclear how much of the AIIB's future projects will be denominated in RMB, many suspect that the establishment of the AIIB and China's concurrent "Belt and Road Initiative" would contribute to RMB internationalization by expanding RMB-denominated investment in the region.

"Now that the easy part of RMB internationalization-trade settlement-has been achieved, the rest of the process will depend on market forces and the Chinese authority's will and ability to liberalize its domestic financial markets."

Japan, the second-largest economy in Asia with a sophisticated financial sector and experience in financial liberalization, has been slow to ride on the RMB internationalization wave perhaps not to annoy, the US, Tokyo's security guarantor. In turn, Japan has contributed to the dollar's persistent dominance in Asia. At the same time, the Japanese economy is becoming sensitive to currency competition as the country deepens its financial integration with the rest of the world.

Copyright Business Recorder, 2018

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