JOURNAL | BOOK REVIEWS By: Hongying Wang
|Renminbi Rising: A New Global Monetary System Emerges
By William H Overholt, Guonan Ma, Cheung Kwok Law
(John Wiley & Sons, 2016, 248 pp)
The rapid rise of the Chinese renminbi as an international currency has attracted enormous attention from scholars, policy analysts and the global financial community in recent years. In this new book, three leading economic experts affiliated with the Fung Global Institute in Hong Kong take the study of this important topic further, adding new insights into the drivers, progress and future prospects for the internationalization of the renminbi, or RMB. The book covers a wide range of issues in great detail.
As the authors make clear, the internationalization of the Chinese currency has been a consequence of converging trends in its economy and the international financial system, including domestic reform and the growing problems with the Bretton Woods institutions. They argue that the future trajectory of the renminbi as an international currency will continue to be shaped by these trends. In particular, they focus on three conditions for Beijing to become the issuer of a global currency: liberalizing China’s financial system, developing capable and credible institutions, and deepening capital markets.
First, in contrast to many studies that stress the foreign policy motivations behind Beijing’s push for the renminbi’s internationalization – for example, enhancing China’s economic and political influence in Asia and reducing the domination of the United States in the international financial system – this book emphasizes the connection between RMB internationalization and the transformation of China’s domestic economy.
According to the authors, after three decades of high growth rates, China now faces substantial challenges in changing the engines driving its economy. Instead of relying on investment, exports and state-owned enterprises, it must in the future rely more on domestic consumption, innovation and small- and medium-sized enterprises, mostly private ones. This will require a more market-driven financial system and more efficient allocation of financial resources.
The Chinese government has accelerated financial reform in order to sustain economic growth, including significant progress in liberalizing interest rates, loosening control of exchange rates and reducing capital controls. These reforms are exactly what renminbi internationalization requires. From this perspective, the needs of the real economy are driving the kinds of financial reforms necessary for internationalizing the Chinese currency. And as the RMB becomes more internationalized, it in turn will facilitate further financial liberalization and economic growth, forming what the authors call a “virtuous circle of reforms.”
This book expresses considerable optimism about the prospects for further financial reforms that will enable the renminbi to gain a greater international role. This optimism may be justified, but it may not be. As the authors acknowledge, further financial liberalization is politically difficult because it threatens the vested interest of those sectors and groups benefitting from the old economic growth model. The authors seem quite confident that reforms will forge ahead, pointing to the new Chinese leadership’s demonstrated ability to implement major change.
The assumption is that the leaders are determined to carry out the necessary reforms. The authors go so far as to assert: “To impose politically difficult reforms, [Beijing] has streamlined its top leadership and wielded an anti-corruption campaign.” Such a view of the political priority of the leadership and the logic of the anti-corruption campaign is quite different from the observations of many existing studies and reports. Since it is central to the book’s prognosis of the trajectory of renminbi internationalization, it needs to be better substantiated.
Second, the book offers a rich and thoughtful treatment of the institutional foundations of renminbi internationalization. Numerous studies have noted that, unlike previous global currency issuers (mainly Britain and the United States), China does not have a democratic political system and a strong system of rule of law. This, they argue, poses a serious obstacle for the Chinese currency to achieve a truly global status. After all, investors hesitate to hold the currency of a country that does not have strong legal protection of property rights and falls short in providing fair and transparent dispute settlement. The authors readily agree with this general observation, but go far beyond it. They offer a detailed analysis of the quality of specific institutions, particularly the People’s Bank of China, the country’s central bank.
As the book points out, a central bank issuing a major international currency has to be credible and trusted. It compares the central bank with the central banks behind other global currencies, especially the US Federal Reserve and the European Central Bank. It contends that as a relatively new institution, the People’s Bank of China does not have the experience of the Fed, nor has it had time to develop the reputation the Fed has.
But, in the long run, the Chinese central bank has certain advantages over the European Central Bank, because it does not have to deal with the competing sovereign interests faced by the latter. The book examines the record of the central bank in controlling inflation, maintaining the value of the RMB, preventing financial crises and preserving financial stability. It shows that the People’s Bank of China has reached a relatively high level of maturity and compares favorably with the central banks of other emerging economies. Looking ahead, the authors recommend that the Chinese central bank should move to a more market-based monetary policy regime, improve its communications with investors and be more transparent with financial data.
The case of the People’s Bank of China is quite intriguing. Conventional wisdom stipulates that central bank independence is crucial to its credibility. If a central bank follows the needs and preferences of the political party in power its monetary policy is likely to be unpredictable and unsound. As the authors of this book admit, the Chinese central bank lacks independence from the government (for example, important monetary decisions need to be approved by the State Council, China’s cabinet). However, it has been able to manage monetary policy quite well. This book credits the People’s Bank of China with being highly professional and reform-oriented, but does not provide an in-depth analysis of why a politically controlled central bank has performed so well so far, or if this factor will constrain its future as a credible and trusted issuer of a major global currency. It is an important and interesting question awaiting further study.
Third, China’s lack of deep and sophisticated capital markets is widely seen as a major obstacle for the country to play a more prominent role in international finance, including having its currency act as a global currency. This book provides a careful and informative analysis of China’s financial markets, with a special focus on the bond market.
It shows that although China’s overall leverage of government, corporations and households is quite high, at around 250 percent of gross domestic product, its bond market is very small, about one-tenth of the size of the US bond market, ranking the lowest among the world’s top 10 bond markets in relation to GDP. Moreover, the Chinese bond market is fragmented, falling under different regulators. Meanwhile, its stock market is plagued by fundamental flaws, as shown by the recent turmoil and the government’s poor response to it. The banking sector, which accounts for the largest share of renminbi financial assets globally, is still largely closed to foreign participants, with foreign banks accounting for only 2 percent of bank loans and deposits.
The authors urge China to expand its bond market, especially by increasing the size of the market for government bonds and making them more accessible to foreign investors. They believe that bold policy initiatives can lift the bonds to the top third of global treasury markets and make foreign holdings of Chinese government bonds twice the projected size of offshore RMB-denominated bonds by 2020.
The economic analysis is based on abundant data and insightful comparisons with other financial markets. What is missing is a sophisticated political analysis of the development (or lack thereof) of China’s capital markets. Why has the banking sector been so dominant in its financial system? Who stands to lose from a bigger, more integrated and better regulated bond market and stock market? What ideological and strategic considerations have hindered reform in this area? Without a clear answer to these questions, estimates of the future size and shape of China’s capital markets can be quite shaky.
Besides the arguments discussed above, the book explores many other fascinating issues, for example, the role of Hong Kong and other offshore RMB centers in the internationalization of the Chinese currency; the impact of the New Development Bank, the Asian Infrastructure Investment Bank and the Silk Road Fund on renminbi internationalization; the effect of the RMB’s entry into the International Monetary Fund’s basket of Special Drawing Rights on its status as a reserve currency; and the utility of the Shanghai Free Trade Zone in internationalizing the Chinese currency. The space limit of this review does not allow me to engage the authors’ often insightful and sometimes controversial views on these issues.
Overall, “Renminbi Rising” is a timely, comprehensive and nuanced examination of the progress and prospects for the internationalization of China’s currency. It makes a significant contribution to our understanding of the nation’s changing role in the international financial system.