RMB internationalization a long-term process

China needs to exercise caution while further opening up its financial sector due to two reasons. One, because it lacks well-developed financial infrastructure. And two, because the mismatch in the market-based exchange rate and interest rate and financial opening-up could destabilize its financial market.

Further opening-up of China's financial sector requires the authorities to be vigilant against abnormal fluctuations caused by large-scale short-term capital inflow and excessive appreciation or sharp depreciation of the renminbi. Also, the country could face increased risks due to excessive cross-border capital flows. Therefore, China should build a mechanism that would enable market-oriented allocation of production factors to boost competition in and ensure the healthy development of its financial market.

Given that financial risks will hinder financial opening-up, China should attract more foreign financial institutions to help their domestic counterparts to reduce and overcome competitive risks. The government also needs to encourage domestic financial institutions to "go global", and use "legitimate supervision", instead of "reasonable supervision", over their foreign investment to overcome financial risks. And the authorities should pay closer attention to financial risks arising out of US-China trade disputes.

Besides, the further opening-up of its financial service sector will increase the risks for the financial market in these times of trade shocks and increasing uncertainties. Hence, China needs to strictly monitor capital flows while advancing its two-way opening-up in the capital market, and prevent speculative cross-border capital and hot money inflows and outflows.

There is also a need to build a cross-border renminbi settlement mechanism to promote high-quality financial opening-up, and develop a financial supervision system and a mechanism to prevent and control risks, in order to minimize the volatility risks facing the financial market.

More important, since China is under huge employment pressure, it cannot risk a big deficit imbalance caused by the hasty internationalization of the renminbi.

A sovereign currency becomes a fully convertible international currency on the basis of its country's comprehensive national strength and guarantee to reimburse the value of its currency.

Although China has met some of the financial and political requirements for the renminbi's internationalization, it still faces some difficulties in the internationalization of its currency due to rising trade protectionism and yet-to-be-fully-developed domestic currency, capital, foreign exchange, and financial derivatives markets.

There are two criteria for a country's currency to become an international reserve currency. One, the country has to be one of the biggest consumption destinations of final goods in the world, meaning it should have the capability to inject liquidity into the market. And two, it should be able to attract international investors for initial public offerings on its stock exchange, which would indicate it has the ability to boost liquidity and handle a huge current account deficit imbalance. But since China, as a developing country, cannot yet do so, it should not accelerate the process of the renminbi's internationalization.

Moreover, the number of fresh college graduates this year was a record 11.58 million, up 820,000 year-on-year. To ensure their employment, China needs to achieve sustainable and rapid economic growth, a goal which can be met through massive exports and foreign direct investment. The internationalization of the renminbi being a long-term process could make achieving that goal a bit difficult.

Some foreign media and experts mistake China's currency swap agreements with countries such as Russia, Brazil, Saudi Arabia, France and Iran as significant efforts to accelerate the renminbi internationalization. But according to General Administration of Customs data, China's exports to and imports from Russia accounted for only 3 percent of its total trade in 2022; the figure is 2.7 percent for Brazil, 1.8 percent for Saudi Arabia, 1.3 percent for France, and 0.3 percent for Iran.

In contrast, China's exports to and imports from the European Union, the United States and Japan accounted for 13.4 percent, 12 percent and 5.7 percent respectively of its total trade in 2022, with most of the deals being settled in the US dollar, the euro or the yen. So the internationalization of the renminbi still has a long way to go.

First, it is necessary to see what currency China uses for trade settlement with its major trading partners such as the EU, the US, Japan and the Republic of Korea. Second, it's important to determine the renminbi's share in the Society for Worldwide Interbank Financial Telecommunication. For example, the renminbi's global share stood at 2.15 percent in December last year, while the US dollar and the euro accounted for 41.89 percent and 36.34 percent. And third, it's also necessary to calculate the currency's share of global foreign exchange reserves — by the end of the fourth quarter of 2022, the share of the dollar was 58.36 percent, the euro 20.47 percent, and the renminbi 2.69 percent.

Currency swap agreements between China and some other countries cannot be the sole criterion for the renminbi's internationalization. Actually, some countries were forced to sign currency swap agreements because of the dollar's declining liquidity. Still, irrespective of whether the US Federal Reserve adopts quantitative easing policy again, the US dollar will remain the most important currency for global trade and foreign exchange reserves.

Shen Guobing is a professor at the School of Economics and deputy director of the Institute of World Economy at Fudan University. Liu Weiping is a researcher at the China Development Bank.

The views don't necessarily reflect those of China Daily.