China's Central Bank has taken further action on the RMB marketization and internationalization, by widening the RMB exchange rate's floating band within the inter-bank market from 0.5 percent to 1.0 percent. Becoming effective on April 16, 2012, this policy has been seen as a strong signal to the world that the RMB exchange rate regime is going to be driven more and more by market forces, than by government intervention. Widening the trading band does add credibility to RMB marketization, but does little for the notion of RMB internationalization at this stage.
RMB marketization is the ultimate goal of the RMB reform. Indeed, the value of the RMB has been rising since 2005, yet, meanwhile, the degree of government intervention in China's Foreign Exchange Market has been falling since then. The truth is that China's external surplus has dropped to 2.8 percent of its GDP in 2011, from 10 percent in 2007. With a 0.5 percent of larger trading band, the RMB exchange rate is expected to be more market-driven, but with a narrowed surplus.
Over the last decade, the Chinese currency issue has been one of the most popular and controversial issues in international political economics. Economists, particularly those from the US, have conducted tremendous research which addressed the effects and implications of China's currency revaluation. While most economists concluded that China's currency is still undervalued, they have also recognized that the RMB appreciation is an on-going process; slow but gradual.
The Chinese government is very cautious with respect to the pace of the RMB appreciation. The reason is simple: a stable RMB is not only an important factor for the Chinese economy, but also a realistic choice for the global economic recovery.
In fact, faster appreciation of RMB is very risky for the Chinese economy. With the US and EU markets still recovering from the economic recession, Chinese exporters have suffered dramatically. As an export-driven trading nation, if China appreciates its currency faster, that will worsen already less-than-favorable trading terms which in turn will increase the suffering of exporting manufacturers.
Nevertheless, at the international level, for example, reforms on the RMB regime have indeed made the American political debate on defining China as a currency manipulator weaker and less plausible. That is why the US Treasury has postponed its publication on China's currency to the Congress again and again.
Market-oriented RMB appreciation also matters to the developing world. As "Made in China" is becoming less competitive, as a result of the RMB appreciation, developing nations with labor-cost advantages will continue to gain larger global market shares in the export sectors. While targeting China's huge potential consumer market, developing nations, particularly emerging economies, also see China as a key competitor on the global market. This may be well represented by the twist of "love-to-hate" and "hate-to-love" relations between China and the rest of the world.
In comparison with marketization, the RMB internationalization is relatively more controversial, complicated, and politically sensitive. Aside from the significant internal consequences of the RMB becoming an international reserve currency, the resulting external consequences would be equally severe and highly leveraged by economic and political power, at both domestic and international levels. Therefore, China may have to pursue a quicker marketization process, but a slower internationalization process.
The next step for RMB internationalization is probably to promote wider use of the RMB as an international settlement currency. China has made remarkable progress in recent years, with respect to its cross-border trading partners. However, still less than half a percent of international trade is settled by using the RMB now. It may take another decade for China to have the RMB play a major role in international settlement.
Theoretically, full convertibility would be necessary for RMB internationalization. Needless to say, the Chinese government is concerned not only about capital flow control, but also about further banking reforms. To what extent China can manage its capital markets, while liberalizing its banking industry, and, at the same time, avoiding external turbulence, remains unknown. This insecurity in financial sectors hits home at the heart of the future Chinese monetary and exchange rate policy.
Currently, with a slowdown in economic growth, high inflation pressure and challenging export markets, it is unlikely that China's RMB internationalization will come to pass soon. Patience is needed. In the near future, China's trade surplus will continue to decrease as the RMB marketization continues, but RMB internationalization will take longer than the world expects. The consensus is that a gradually liberalized RMB will benefit both China and the global economy.
The author is a columnist with China.org.cn. For more information please visit: http://www.china.org.cn/opinion/zhanglijuan.htm
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