The Renminbi’s Prospects as a Global Reserve Currency

Popular discussions about the prospects of China’s currency — the renminbi — range from the view that it is on the threshold of becoming the dominant global reserve currency to the concern that rapid capital-account opening poses serious risks for China. A number of recent academic studies have pointed to the renminbi’s rising importance in the international monetary system, although these studies are divided on the renminbi’s prospects of becoming a dominant global reserve currency.

These are legitimate and important issues, as the rise of China’s economy and its currency have implications for global macroeconomic and financial stability. It is interesting that, of the currencies of the world’s six largest economies, China’s renminbi is the only one that is not a reserve currency. Even though the economy has neither a flexible exchange rate nor an open capital account, the Chinese government has recently taken a number of steps to increase the international use of the renminbi. Given China’s rising shares of global GDP and trade, these steps are gaining traction and signal a rising role for the renminbi in global trade and finance.

In recent research (Prasad and Ye 2011), we explore the prospect of the renminbi becoming a global reserve currency. The popular debate often conflates three related, but distinct, aspects of the renminbi’s role in the global monetary system:

  • Internationalisation: Its use in denominating and settling cross-border trade and financial transactions, that is, its use as an international medium of exchange.
  • Capital-account convertibility: The country’s level of restrictions on inflows and outflows of financial capital. A fully open capital account has no restrictions.
  • Reserve currency: Whether the renminbi is held by foreign central banks as protection against balance of payments crises.

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