Int'l monetary system needs renminbi as 'third leg'

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Former Hong Kong Monetary Authority chief Joseph Yam had said a healthier and more stable international monetary system needed a third leg since evidences showed the U.S. dollar and the euro were not healthy enough with erosive long-term market confidence.

In a recent interview with Xinhua, Yam said the Chinese yuan or renminbi, as a sovereign currency, has the greatest potential to become a third leg though it still has a far long way to go.

Yam also said Hong Kong, as a financial hub blessed with the advantage of "one country, two systems" principle, was an ideal place for the internationalization of the renminbi and to help the renminbi achieve the status as a third leg.

Third leg

Yam, easily recognized with an abundance of silvery white hair, is a famous financial veteran in Hong Kong. Since retirement in September last year, he serves as the executive vice-president of the China Society for Finance and Banking, a think tank under the People's Bank of China, the country's central bank.

According to Yam, the international monetary system was worrisome and seemed structurally unstable, with its two supporting legs -- the U.S. dollar and the euro -- not commanding the level of international confidence needed to sustain their status.

The overall economic pictures of the U.S. and the euro-zone, the quantitative easing monetary policies and the level of indebtedness all had an adverse impact against investors' long- term confidence over the two currencies, he said.

"Then how to stabilize it? (We) need a third leg (the Tripod Model), either in the form of non-sovereign currency, such as the Special Drawing Rights (SDRs) created by the International Monetary Fund (IMF) or new Asian Currency Unit, or in the form of a sovereign currency," he said.

Yam said chances of a sovereign currency becoming a third leg were higher, since few economies were willing to use the long- existing SDRs and many people would have reservations about new Asian Currency Unit given the experience of the euro.

"If the third leg falls in the form of a sovereign currency, it must be the renminbi," he said, citing China's growing economic size and effective macroeconomic management over the last two decades.

To become a third leg, however, the renminbi needs much more good preparations and achieves the internationalization, Yam said, adding recent moves by China's central bank indicated the country was pushing forward with the internationalization of the renminbi step by step.

On June 19, the central bank decided to proceed further with the reform of the renminbi exchange rate to add flexibility to the renminbi exchange rate. Days later, it decided to expand a trial program for settling trade deals in the renminbi to most of the country.


According to Yam, the internationalization of the renminbi and becoming a third leg of the world's monetary system would take many years, and wouldn't be achieved without meeting five conditions.

The first requirement is the economic size. China's economic size, if measured by the gross domestic product (GDP), should be similar to that of the U.S. and the euro zone, which commands international confidence for the renminbi.

Currently, China's GDP is about one third of that of the U.S. and the euro zone. In 2009, China's GDP amounted to 5 trillion U.S. dollars, while GDP of the euro zone was equivalent to some 16 trillion U.S. dollars and U.S. GDP stood at 14.2 trillion dollars, according to IMF figures.

Second, China needs to continue implementing effective macroeconomic policies in the next several decades and keeping steady growth. Yam said that China has been implementing effective macroeconomic policies over the past more than 20 years which promotes and strengthens international confidence in its currency.

Third, the renminbi should be fully convertible and China needs eventually to remove all capital controls. "The full liberalization of the capital account has wider ramifications than the internationalization of the renminbi and will therefore have to be handled carefully, emphasizing on gradualism, controllability and the ability to take the initiative," Yam had said.

Fourth, China needs to set up an extensive and mature renminbi- denominated investment market, which would allow foreign individuals and institutions to use the renminbi in financial transactions freely, he said.

The fifth and last condition is to build modern financial infrastructure to support a real-time gross renminbi settlement system, Yam added.

Hong Kong's role

Yam said the internationalization of the renminbi can be organized through the development of an off-shore renminbi market that operates under the open international market environment, while the off-shore market will provide important signals to guide full liberalization of the capital account in the on-shore market.

Hong Kong, as an international financial hub, could play big in the internationalization of the renminbi, said Yam, who helped start off-shore renminbi-denominated transactions in Hong Kong.

In a visit to Beijing 2001, Yam made a proposal to Chinese central government officials that there was a need for a proper channel for the increasing amount of renminbi banknotes circulating off-shore, particularly in Hong Kong, to be returned to the mainland.

In 2004, after a series of discussions with the central bank, HK banks began to take renminbi deposits from local residents, among other modest banking activities, marking the beginning of a renminbi off-shore market in Hong Kong.

Yam, however, was far from satisfied with the development of HK's renminbi off-shore market. He said the volume of renminbi business in Hong Kong was still relatively small and there are not many renminbi assets that the settlement bank can buy through the creation of renminbi liabilities.

Figures released by the Hong Kong Monetary Authority indicated the city's deposits of the renminbi stood at 84.7 billion yuan (12. 5 billion U.S. dollars) at the end of May this year. Renminbi bonds in Hong Kong amounted to some 30 billion yuan (4.4 billion U. S. dollars).

He suggested more aggressive steps should be taken so as to expand renminbi business in Hong Kong, as long as a proper working relationship between the on-shore and off-shore renminbi markets was set up to serve the development and risk management needs.

The 62-year-old veteran thus gave some advice for further development of renminbi business in HK -- setting up an architecture that should enable the on-shore impacts of off-shore activities to be monitored closely, allowing HK to manage the renminbi business in its own ways as long as the risks are controllable, and enhancing the mobility of renminbi between the two markets.

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