The U.S. dollar has decreased in value against China's RMB by roughly 23 percent over the past seven years. [File photo]
Responding to a written interview from the Washington Post and Wall Street Journal in 2011, President Hu Jintao described the current U.S. dollar-led currency system as "a product of the past," and summarized China's recent moves at "internationalizing" the Renminbi (RMB).
Although many critics accuse China of undervaluing its currency to make its exports more competitive on overseas markets, Beijing has demonstrated a tangible commitment to removing currency controls and is beginning to encourage limited use of the RMB in cross-border trade and investment.
The RMB removed its fixed exchange rate against the U.S. dollar (USD) in mid-2005, and now floats within a narrow margin approved by the Chinese central bank. Over the past seven years, currency markets have decreased their valuation of the USD against the RMB by roughly 23 percent. A thriving off-shore RMB bond market continues to gain traction in Hong Kong, a portion of China's trade is now invoiced in RMB notes and foreign central banks are beginning to hold RMB reserves. This leads many to question if the currency is ready to make its debut as a recognized reserve currency.
A fresh look
Celebrated economists Eswar Prasad and Arvind Subramanan discussed the possibility of the RMB challenging the dollar's dominant role in global financial transactions at the Indian Embassy in Beijing on Feb. 28.
Eswar Prasad is a senior fellow at the Peterson Institute for International Economics and the Center for Global Development. Foreign Policy magazine named him as one of the world's top 100 global thinkers in 2011. Arvind Subramanan is the Tolani Senior Professor of Trade Policy at Cornell University. He is also a senior fellow at the Brookings Institution, where he holds the New Century Chair in International Economics, and a research associate at the National Bureau of Economic Research.
Moderated by Andrew Browne of the Wall Street Journal, the talk focused on what challenges China would face should it push for RMB internationalization.
"Containment won't work," Subramanan said of potential U.S. strategies regarding China's growing economic influence. "Empowerment and engagement will be the best practice."
His advice to U.S. policymakers reflects the reality on the ground: Attempting to limit or hinder China's economic growth would be inadvisable.
"We need to maintain the open financial system bequeathed [to China] by the U.S. We need to create a multilateral system that includes China," he said. "That's what I mean by engagement."
A slow process
In addressing the likelihood of the RMB challenging the USD as an international currency, Prasad argued that the subject was not as significant as the media often makes it out to be. He predicted that over the next five years, the RMB will grow to become part of "a basket of currencies" held by the International Monetary Fund (IMF), "not because China needs the IMF, but because the IMF needs China."
Prasad's tone points toward a growing belief among economists: The international community will gain more from Chinese investment and an appreciating RMB than the Chinese economy itself.
Although China's domestic economy has been struggling to combat inflationary pressures, Hu dismissed Western calls for China to accelerate the RMB's appreciation in his 2011 written interview to the Washington Post and Wall Street Journal.
The Chinese president wrote that Beijing is responding to inflation with a robust package of policies that include interest-rate increases, and that "inflation can hardly be the main factor in determining the exchange rate policy." While acknowledging China's aim to make the RMB a recognized international currency, he admitted that it "will be a fairly long process."
Despite the government's entrenched resistance towards rapid RMB appreciation and a more open financial services sector, Prasad said that central banks are already signaling that they are warming up to the idea of using the RMB as a limited reserve currency. He added that he did not believe the RMB would replace either the USD or the euro in the near future, and that China must accelerate the restructuring of domestic financial services if it wants to see any benefits that stem from increased foreign-held RMB reserves.