Ask a Senior Analyst — Miriam L. Campanella

Wikistrat’s Facebook and Twitter followers recently engaged in a 24-hour exclusive Q&A session with one of Wikistrat’s Senior Analysts, Miriam L. Campanella. Questions and Ms. Campanella’s answers are transcribed below.

Miriam Campanella

Miriam L. Campanella is a Jean Monnet Professor at the University of Turin and a ECIPE Senior Fellow. She has published extensively on European monetary and financial institutions, contributing to several edited books and journals. With Sylvester C.W. Eijffiger, she co-authored EU Economic Governance and Globalization (2003). Since then, her research focus has shifted to Asia and the region’s attempts to build up independent monetary and financial facilities.

Omololu T. Hebron: What will be the implications of monetary and financial integration in East Asia on the economies of the developing countries? Will these developing economies benefit more in such a regional bloc in terms of manufacturing and boosting of their domestic economy?

Answer: Your question touches on a major issue in economics, as it relates to monetary integration, a proxy of a fixed exchange rate via an anchor-basket or a major currency (or a synthetic currency, as the European Currency Unit in the European Monetary System) that delivers trade-promoting gains for the parties involved.

European Union (EU) members with the bilateral Exchange Rate Mechanism (ERM) in 1980, and European Monetary Union (EMU) in the 1990s, took almost three decades to stabilize exchange rates and finally establish a single currency. This coordination exercise helped indeed to adjust EU economies to meet in some way the parameters of an optimum currency area, conditional to the success of a single currency. According to economists of different quarters, this way is barred to East Asian countries as the U.S. dollar plays a pivotal role in the area.

Given that the Europeans took three decades to work out a regional exchange rate diplomacy, and to adopt the euro, East Asia, in the wake of 2008-2009 financial crisis, started moving in a surprising way. The collapse of trade financing during the crisis, which contributed to a 20 percent drop in China’s exports, made Chinese authorities aware of the intrinsic instability of the existing monetary regime which is based on one national currency that performs the role of global reserve currency. In order to bypass the U.S. dollar, the middleman of regional trade, the People’s Bank of China intensified bilateral currency swap agreements signed with other central banks to insure against a repeat of these events.

A second defining moment came with the RMB becoming a reference exchange-rate anchor. When this role intensifies, a currency bloc tends to develop around the reference currency whose monetary policy becomes dominant. Since 2010, the RMB has surpassed the dollar and the euro by becoming the top reference currency in East Asia and the Philippines. The dollar’s dominance as reference currency in East Asia is now limited to Hong Kong (by virtue of the peg), Vietnam and Mongolia. Yet the RMB as the top exchange-rate reference currency is not restricted to East Asia. For Chile, India and South Africa, the RMB is the dominant reference currency. For Israel and Turkey, the RMB is a more important reference currency than the dollar.

These developments are evidence of the relevance of the China’s RMB as an exchange rate stabilizer, a critical factor of trade performance to developing economies.

Allen Li: With the “one currency, two markets” system, China has managed to internationalize the RMB while maintaining a relatively stable domestic financial market. As of today, China has established a number of offshore RMB centers in the major financial hubs around the world and more than forty central banks have allocated part of their foreign reserves to RMB. Will this address some of the defects of the current international monetary system? What changes could the RMB bring to the system? And how long could it take for the RMB to become a major international reserve currency?

Answer: As you point out, the internationalization of the RMB is mostly a policy-driven upshot of China’s monetary policy. In addition to China’s trade prformance, which in some way I have dealt with in the answer to Omololu T. Hebron’s question, domestic financial factors play a critical role.

Counterintuitively, a major objective of the internationalization of the RMB is not primarily a challenge to the U.S. dollar and the euro. Its primary objective is to set off the country’s financial liberalization. China’s heavily regulated domestic interest rates, capital controls and the non-convertibility of the RMB represent a textbook example of financial repression.

Under normal circumstances, the internationalization of the RMB would have first occurred at the domestic level, by deregulation of domestic interest rates, liberalization of the capital account and finally pushing forward the international use of the currency. After announcing several times the country would follow this standard sequencing, and having stopped suddenly at the early signs of capital flight, China’s leaders opted to do exactly the reverse. Since 2000, policymakers have started implementing the internationalization of the RMB, looking for a “backdoor” policy to circumvent powerful stakeholders (state-owned enterprises), which control around 85 percent of loans, and to tackle the problem of “shadow banks,” which are less tightly regulated and likely to have far looser lending rules — whose failure would have the knock-on effect of a Lehman Brothers collapse.

The rise of the RMB at the global stage, and the liberalization policy choices, are likely to encounter fierce opposition from these stakeholders. Yet China’s authorities are compelled to act, as financial liberalization is the only way to hold back a serious banking crisis. China’s bank lending has skyrocketed in the last five years and bad debts have reached a new high. According to recent figures released by the China Banking Regulatory Commission, “non-performing loans rose by 28.5 billion RMB ($4.7 billion) in the last quarter of 2013 to 592.1 billion RMB, the highest since September 2008.”

The benefits of the RMB’s internationalization extend far beyond China’s domestic economy. At this stage — which could require at least a decade — the RMB as a full-fledged global currency, as an equal to the dollar and the euro, will make the international monetary system more stable and less prone to financial turbulence and crashes.

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