ROME/MADRID – The Chinese are losing confidence in their currency. Faced with faltering economic growth, the People’s Bank of China has stepped up efforts to restore stability to the renminbi, using its vast foreign reserves to prop up its exchange rate and stem the flow of funds fleeing the country.
The PBOC’s governor, Zhou Xiaochuan, has repeatedly stated that there is no basis for continued depreciation, but few in the country seem to be listening. In the last quarter of 2015 alone, the net capital outflow amounted to $367 billion.
And yet crumbling confidence within China has not prevented the West – and Europe in particular – from doubling down on the currency. When the International Monetary Fund announced in December that the renminbi would join the U.S. dollar, the British pound, the euro, and the Japanese yen in the currency basket underlying its unit of account, the Special Drawing Rights basket, the decision was clearly political.
Few would argue that the renminbi meets the IMF’s criteria for inclusion in the SDR currency basket. It is not freely convertible, and access to it is limited both inside and outside China. Some foreign branches of Chinese banks offer renminbi-denominated deposit accounts, and qualified investors can purchase debt instruments pegged to the currency in mainland China. But the volume is capped.
To be sure, the renminbi performs well in trade-related statistics. According to the financial network SWIFT, it is the second most used currency in trade finance, having overtaken the euro, and ranks fifth in terms of international payments. These figures are inflated, however, by transactions with Hong Kong, which accounts for roughly 70% of international trade payments settled in renminbi.
Vanishingly few contracts are issued in renminbi; the dollar remains king in invoicing, with the euro a distant second. Even the shares of the Japanese yen and the British pound, though very small, are still higher than that of the renminbi.
The IMF’s decision to add the Chinese currency to the SDR basket owes much to the decision by the United States to defer to Europe. The US had argued for years that the renminbi should be included in the SDR only if China opened its capital account, let its currency float freely, and had a more independent central bank. None of this has happened.
But after China established the Asian Infrastructure Investment Bank with the support of Europe, the US agreed to drop its objections. After all, the SDR basket plays a minor role in global finance, and admitting the renminbi was seen as a small price to pay to keep China embedded in the Bretton Woods institutions.
Europe’s investment in the renminbi, however, goes far beyond political symbolism. The continent’s leaders have been strong supporters of the internationalization of the renminbi and the efforts of reform-minded officials such as Zhou. The currency’s inclusion in the SDR, it is hoped, will encourage China to liberalize its capital account further.
European governments and central banks are also actively working to make the renminbi a viable reserve currency, to increase trade with China. British Chancellor George Osborne has made it clear that he would like the City of London to be the most important offshore market for renminbi trading and services. It was no coincidence that during President Xi Jinping’s state visit to the United Kingdom in October 2015, China chose London to issue its first overseas renminbi sovereign debt.
Almost sure to fail
The rest of Europe is equally enthusiastic. Today, the continent is home to the largest number of renminbi bank clearings. Offshore renminbi hubs have emerged in Frankfurt, Paris, Milan, Luxemburg, Prague, and Zurich, and most of Europe’s central banks have added – or are considering adding – China’s currency to their portfolios. In October 2013, the PBOC and the European Central Bank signed a bilateral currency swap agreement for €45 billion ($50 billion), the largest ever for China outside of Asia.
By propping up the renminbi as a reserve currency, Europe is hoping to support the liberalizers inside China and welcome the country to the core group of world powers that decide global monetary affairs.
Unfortunately, however, it is doing so at a time when the renminbi is under speculative attack and the Chinese themselves are losing confidence. Europe’s efforts could succeed; but unless China makes its currency even more widely accessible and opens its market further, they are almost sure to fail.