Renminbi has the potential to create a seismic shift in the international monetary and financial landscape

Evidence is emerging that international finance will take over from trade as the principal projector of China's global influence.

In a speech in Sydney in March, Philip Lowe, deputy governor of Australia's central bank, said: "The internationalization of the renminbi - and China's associated move toward a liberalized capital account and more flexible exchange-rate regime - has the potential to create a seismic shift in the international monetary and financial landscape."

In the same month, the Bank of International Settlements, based in Switzerland, released a research report showing that the renminbi has become a more important influence on other Asian currencies than any of the major global currencies.

How long will it be before China becomes a major global force in financial affairs, rivaling the United States? What will the global impact be when it happens?

In March 2009, the governor of the People's Bank of China, Zhou Xiaochuan, published a now-famous essay called Reform the international monetary system, calling for a modernization of the monetary system by basing it on a money standard which stood above national currencies. The United Nations Commission of Financial Experts into the Reform of the Global Monetary and Financial System, reporting in September 2009, supported Zhou's appeal. But Japan and the European countries (excluding Russia) followed the United States in ignoring calls for monetary reform.

China gave up the idea of changing the global monetary system, and adopted a different strategy aimed at protecting its economy and large pool of savings: developing its own currency, the renminbi, as a major global currency to rival the dollar. An internationally-recognized, widely-used renminbi would protect China's savings, and bring Chinese the great convenience and lower cost of using the renminbi everywhere outside China. It would also make China into a global financial power.

In 2009, when renminbi internationalization started, most commentators paid little attention to it, believing it would take several decades for the Chinese currency to become a major financial force. But since then, China has pushed ahead, step by step, to promote the use of its currency outside of the country. In 2009, only 1.1 percent of bank deposits in Hong Kong were held in renminbi. By February this year, the total had risen to 12.4 percent of Hong Kong's total bank deposits. In 2010, less than 1 percent of global trade was settled in renminbi. Today, the proportion is approaching 20 percent.

In 2007, the first renminbi-denominated bond (or dim sum bond) was issued outside China. By March this year, the total issuance in offshore dim sum bonds was $60 billion, with much more on the way. Offshore trading in Hong Kong of the renminbi has developed quickly, from the unofficial market created by Chinese exporters a decade ago (the non-deliverable forward market) to today's large offshore renminbi market centering on renminbi held outside mainland China.

Recently, promotion of the renminbi's international role has extended into Europe, with the signing of agreements with the German and British governments to make Frankfurt and London into centers for renminbi settlement, joining Hong Kong, Singapore and Taipei. The renminbi now ranks ahead of the euro, and behind only the US dollar, as No 2 in trade finance; and ahead of the Swiss franc as No 9 in global payments.

But the renminbi's rise has owed much to China's dominant role as the major trading partners of other Asian countries. More than 80 percent of the international payments which use the renminbi presently involve the Chinese mainland or Hong Kong. The renminbi won't become a global currency until it is widely used outside Asia by non-residents for conducting transactions, for borrowing, and for making investments that don't involve China. Investors around the world will not regard the renminbi as a currency they can rely on until it is freely traded, and can flow freely in and out of China, or is fully convertible.

Some experts argue that in addition, the renminbi can't become a global currency to match the dollar until investors feel that the rule of law predominates in China, so that international renminbi creditors can protect themselves by effectively pursuing claims through legal process there. Whether this is a binding condition is uncertain. What is clear is that full renminbi convertibility is necessary for a truly internationalized renminbi.

How long will it be before China achieves full renminbi convertibility? In December 2012, former central bank governor Zhou made an important speech at a conference in Hainan, in which he indicated that currency convertibility was both a goal of the government, and in sight, although a lot of work still had to be done. It appears from more recent comments by Zhou that full renminbi convertibility could come within the next two or three years.

Although a freely traded currency is not the same as full convertibility, we can see that the recent widening of the daily trading band of the renminbi to 2 percent up or down is a further move toward a freely traded Chinese currency. A freely traded, fully convertible renminbi could be with us by 2016 or 2017. It may take a year or two more for China to develop the deep, liquid and transparent renminbi-denominated stock and bond markets which renminbi holders can invest in. The recent announcement linking the Hong Kong and Shanghai stock markets is an important step in this direction.

We can see a time in a few years when China's currency will be seen as a major global currency alongside the US dollar and the euro, and when the comments of China's central bank will be listened to by the global investing community as closely as the comments of the governor of the US Federal Reserve and the European Central Bank are today.

If so, by around 2020, China's global financial influence will have approached that of the US and the EU bloc. The world will have entered a new era of multilateral currencies. The resulting three-legged global currency system will produce a fairer and more stable global economy, and will extend China's impact on existing asset markets, from stocks and bonds to commodities, real estate and precious metals. This will be of great benefit to China in terms of convenience, the profits to be made from issuing a globally used currency, and the acceleration of economic reform which further financial opening-up will bring to China. Inevitably, some of the gain for China in terms of convenience, lower borrowing cost and global influence will be at the expense of the United States and the dollar, but the trend is unstoppable.

The author is a visiting professor at Guanghua School of Management, Peking University. The views do not necessarily reflect those of China Daily.

(China Daily European Weekly 05/09/2014 page10)