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Is it inevitable that the Renminbi will become the next reserve currency?

Essay by Manoj Gupta, SP Jain Institute of Management, Mumbai


Why crude oil, gold and metals are measured always in dollars as an international benchmark to gauge an index? Why most of the international transactions happen in US dollars? Answer is simple, at present more than 60% of world’s central bank reserve is US dollars and USA has been the most stable and reliable economy for a long time. Imagine if gold per oz is pegged at 630 RMB and Oil per barrel is priced at 10000 RMB while the RMB exchange rates are religiously tracked by every trader. Does this sound interesting and little different than what our ear is normally use to hear? Yes, we are talking here about Renminbi (RMB), the official currency People's Republic of China (PRC), which will certainly become world’s next reserve currency in the coming era and eventually take over US dollars. It does look murky at first glance but after a deeper insight one would be amazed to see how the saga of Chinese currency is just about to begin.

For any country the easiest and quickest way to liquidate an asset is to hold reserve of something which everyone else holds that too. But what if the demand and hence the pressure is only on single currency? And icing on the cake would be one fine day the economy of this currency faces some severe damage. We have seen how subprime lending crises of 2008 just rattled the US dependent economies and postulated that too much dependency on a single currency is very detrimental for the world economic stability.

If we follow a simple rule book, then the immediate strong candidate to surpass US dollars is the Euro, but Euro lands have not been able to travel far east and create the dependencies with these far east countries and moreover Euro is too young and its formation out of amalgamation


of 17 European nations currency makes it too vulnerable to any economic state of these 17 countries and hence shares the pie with around 25%.The Japanese Yen due to its uncertainty and high volatility has not been able to appeal the traders to a significant extent and thus follows euro. While after debacle of Great British Pound (GBP) from a top reserve currency in late 1970s and formation of Euro, GBP for number of reasons such as trade and political reasons it has not been able to pick gain the top spot and hence shares the pie with 4% along with Japanese Yen. On the other hand China has been able to measure the latitudes and longitudes of the earth in terms of international trade, and has left strong footprints in almost all the countries of the world. In total, one would hardly find any nation that doesn’t trade with China. Furthermore, everyone is well versed with the power of Chinese goods and to be competitive in this dynamic market the trade relationship with China has become more a habit now. History repeats itself, just as USA emerged as a superpower in 1970s and surpassed GBP and eventually became the world leader in currency reserve, accounting for more than 60% of total reserve currency in the world, China is not very far to depict the same drama and hence RMB stands out as clean winner.

If a question is asked how many countries do not trade with China or vice versa? The answer is one might find hardly any county which doesn’t trade with China or the other way. It trades with most of counties in the world, global trade accounting for more than $2.5 trillions. It has world’s largest reserve of forex of about $3 trillions. The bilateral trade between China with developed countries is already in a much matured state and while with developing or underdeveloped states is emerging at a very rapid speed and in coming years China will continue to dominate the market. As an effect countries have become too much dependent on China. Furthermore, with the rapid globalization and tough competition in the market, companies are forced to go for a trade with China to get cheap goods. Thus it is inevitable that


any country will survive without trade relationship with China. This seriously summons a switch of local currency or dollar to RMB which would clearly ease the international trade to settle out the transactions.

At present China is the second largest and fastest growing economy. Citing its current growth rate, China will become world's safest and largest investment economy in times to come given the following factors: huge market potential, rich labor resources, comparative advantage in labor cost, sound corporate governance and stable government and society. All these factors will further attract the inflow of foreign capital into China. In the next ten years, China's economy will still increase at a rate 7% - 8%. In 2020 years, should price index remains the same as today, GDP will amount to 38 trillion. To add more, in 2040, the Chinese economy will reach $123 trillion, or nearly three times the economic output of the entire globe in 2000. China's per capita income will hit $85,000 more than double the forecast for the European Union, and also much higher than that of India and Japan. In sum, its economy will grow even faster in the future and China unquestionably will stand as a superpower nation.

RMB is not too far in achieving the status of global currency, however China need to work on its some ground policies to accentuate the process which at the moment is very rigid and highly unfavorable for investments. Firstly China would first need to ease restrictions on money entering and leaving the country which means - make RMB fully convertible. The Central Bank of China should invite foreign investment by opening a strong bond market with high liquidity for such transactions. At the same time to attract foreign investment it needs to increase the interest rates while should continue domestic financial reforms so as not to lose domestic market. There is already a big demand of Chinese market and volume of international trade is continuously growing making it more favorable for demand in RMB too. Once the demand for


RMB goes up, the exchange rates fluctuations would happen which would encourage large scale foreign investments.

Will this be good bet for China? Well, It is believed that China has traditionally devalued its RMB synthetically in order to boost its exports and trade surplus, but this is true only from bird’s eye view and the truth is the positives of being a global currency reserve outweighs the negatives of not being one. If RMB becomes a reserve currency, Just by writing cheques and debit notes China can pay for all the import invoices or any out flowing transactions. Furthermore it will boost China’s power to spend more than it can earn. This is exactly what US has done in recent years. National expenditure of US has exceeded national income by more than 20% over the last five years. To add more International and reserve currency status also lends the host country even greater influence than otherwise. Once RMB gets a leading global currency status, it can influence the world economy just as USA does.

To conclude, citing the above facts, it is in the interest of both China and world economy that RMB becomes an alternate currency reserve. And while China's leading position in global trade makes it quite sensible to increase the use of the RMB for invoicing and settling trade, it is a huge leap from making the RMB more internationally traded to making it an attractive reserve currency. This will not only strengthen the global reserve system but also aid other nations to diversify the currency reserve holdings and increase the confidence of the economy.

BIBLOGRAPHY/REFERENCES 1) www.foreignpolicy.com - Current International market, statistics and role of RMB. 2) www.businessweek.com - Monetary policy and China’s economy 3) www.economictimes.com – Views on RMB as a global currency

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