"The authorities have expressed interest in having the RMB included in the SDR basket. We welcome and share this objective, and we will work closely with the Chinese authorities in this regard."The economy of China has grown phenomenally in the last few decades. The renminbi (RMB), more commonly referred to as the yuan (yuan is the base currency unit of RMB), has gained international recognition. The latest BIS Triennial Central Bank Survey states that the RMB is now the ninth-most traded currency in the global market.
Christine Lagarde, Managing Director, IMF
China has been implementing a number of schemes and global reforms in order to internationalize its currency. The paragraphs below will talk about how the yuan is on its way to become the global currency and other related issues.
The Dollar as a Global Reserve Currency
- For the past few decades, the dollar has been the reliable global currency.
- This has been the case after the World Wars, when Britain's currency was potentially threatened due to the war expenditure. In fact, the reduced reliability on the pound sterling was one of the major factors why the dollar became the global reserve currency.
- The U.S. was the single strong economy during the Wars, and eventually, the dependence of other nations on the dollar made the U.S. an all-powerful nation. Today, the dollar is a universally-accepted currency.
- However, the economic recession of 2007 has weakened the dollar to quite an extent, and many economists have raised doubts over the strength of the U.S. dollar against China's currency, apart from the Yen and the Euro.
- Of course, the RMB is not yet a reserve currency; for this, the IMF has to include the RMB in its Special Drawing Rights (SDR).
The Economy of China
- For a very long time, China followed the command economy system. The economic output of the country was controlled by the central government. The government intended to make China economically independent.
- Thus, there were no privately-controlled enterprises or foreign investments.
- This system led to a rather stagnant economic phase for the nation. The primary reasons for this were very little competition, low standard of living, and reduced trade.
- Post 1978, the country opened up to Western trade and investment, and introduced several economic changes. The exposure to free market policies and subsequent changes led to a rapid economic growth over the next few decades.
- In the year 1979, efforts were taken to boost exports and use state-of-the-art technology to manufacture world-class products.
- The government eliminated trade barriers, which increased market competition and attracted foreign investment.
- Private businesses and entrepreneurship were encouraged.
- Increased productivity and huge capital investment were two major factors that catapulted China into the global market.
- The introduction of economic reforms led to rapid domestic and foreign savings, and this contributed enormously to the GDP of the country.
- The decentralized economy helped development and progress of independent businesses that operated without government interference, and foreign investments helped the productivity levels soar.
- With rapid economic growth, China soon emerged as one of the largest manufacturers in the world.
- Of course, the prices of goods and services in China are much lower than that of the United States; however, certain statistics indicate that China's manufacturing industry helped contribute enormously to the global GDP, even more than the United States.
- One of the primary reasons that helps China gain an edge in manufacturing is possibly the low labor cost.
- The country has a huge population and labor has been easily available. However, recent statistics depict that rising labor costs have led to slight cracks in the industrial sector, which is probably why the Chinese government has been concentrating on increasing the country's productivity levels.
- Another major reason for the economic growth is the foreign direct investment (FDI) flow that took shape in the 1990s.
- As of today, China has high technology exports and significant global FDI outflows―a vital factor that contributes to the global FDI.
- The country is engaged in large-scale exports of electronic goods, furniture, machinery, while it imports ores and mineral fuel.
- After the United States, China is the largest importer of petroleum and coal.
- Chinese goods and services have prominent value in the international market, and several measures have been undertaken to maintain the exchange rate.
The Conflicting Views
- Considering the above points, China has applied to the IMF for the RMB to become a global reserve currency.
- Economists suggest that the RMB has a great chance against the dollar; however, the country needs to continue implementing reforms to maintain its economic condition.
- Many analysts state that the RMB still remains undervalued, due to which China has the advantage of cheaper exports and expensive imports.
- Some of the primary reasons why China wants the RMB to become global currency include a globally recognized reserve status, lower borrowing costs, more influence in price setting, international prestige, and the demand of the RMB.
- Some of the above points have been controversial. One of them being the demand of the RMB. Many analysts assert the importance that RMB commands; yet there are views suggesting the opposite, that the RMB will not be able to stabilize inflation or expand financial markets in the future.
- Certain experts also suggest that the RMB will not be able to liquidate assets.
- One of the main reasons for the skepticism, is the fact that the world will take a lot of time to trust the Chinese currency, given that the USD has been the most viable option until now.
- Also, while the Chinese government asserts that RMB has been used in many international markets, skeptics argue that it has not been used sufficiently enough to even be considered for a world currency.
- Free convertibility is another factor that stands against the RMB becoming a global currency.
- All in all, the RMB commands a lot of importance in global trade, yet there are a number of reforms to be agreed upon for it to become the next global currency.
- Besides the RMB, the USD has potential threats from the Yen and the Euro as well, thus it would be a while before the RMB is accepted as the global reserve currency.
While many experts do claim that the renminbi has a great chance to become the global currency, it is going to take a long time due to the trust value placed on the dollar. Also, there are numerous other economical factors to be considered. Besides, some experts also vouch that the renminbi may work fairly well in the long run, but its immediate short-term success seems to be relatively dim.