BRI and RMB Internationalization

Abstract

Since 2003, RMB internationalization has been advancing amid twists and turns, but the proportion of the RMB in global foreign exchange reserves is still lower than China’s share in the global economy and trade. We believe the root cause is that the RMB has not yet completed a closed loop of cross-border investment and financing. Specifically, the internationalization of a currency entails the expansion of its monetary functions through three basic measures: A medium of exchange, a store of value, and a unit of account. Compared with its function as a medium of exchange, the RMB’s development as a store of value and a unit of account has lagged, and the relatively unbalanced development of these three functions of the RMB has imposed constraints on the process of its internationalization. However, the international monetary system is now moving towards a higher degree of diversification. This requires the RMB to play a greater role in global financial and trade scenarios, in our view.

The BRI provides a good opportunity for RMB internationalization, and the formation of a closed loop for the smooth and convenient circulation of the RMB in turn facilitates the healthy interaction between the BRI economy and RMB internationalization. We believe the BRI provides an opportunity to expand the influence of the RMB. First, China has advantages in trade over BRI countries as a whole, with their trade being highly complementary and conducive to further promoting the functions of the RMB as a unit of account and a medium of exchange. Second, the financial markets of most BRI countries are less developed than that of China, which has opened its capital account to a certain extent, helping to improve the functions of the RMB as a store of value. Therefore, the BRI can contribute to developing the three major functions of the RMB and creating a closed loop of RMB investment and financing, in our opinion. In addition, the formation of a closed loop of smooth circulation of the RMB can also facilitate investment, financing, and trade cooperation among BRI countries, and facilitate the high-quality development of the BRI.

Against the background of changes in the global landscape driven by de-dollarization and de-globalization, and drawing on the German and Japanese experience in currency internationalization, we believe China can give full play to its advantages in economic size and trade volume. First, it can seek breakthroughs in promoting the use of the RMB as a settlement currency and an invoicing currency for cross-border trade with BRI countries. On this basis, it can promote the use of the RMB as a store of value by driving the development and opening up of China’s financial markets, launching more RMB-denominated products and building a closed loop of RMB investment and financing.

We believe the signing of bilateral currency swap agreements could help promote the use of the RMB as a settlement currency, the development of RMB-denominated commodity products could expand the use of the RMB as an invoicing currency, and the development of foreign exchange markets is likely to strengthen the use of the RMB as a store of value. We believe these three measures will play important roles in promoting the internationalization of the RMB in BRI countries.

Author: LI Liuyang, LI Jin, YANG Xiaoqing.

6.1 The Degree of RMB Internationalization Has Significant Room for Growth

Currency internationalization refers to the use of a currency outside its country of issue, and an international currency is used and held by residents or non-residents beyond the borders of the issuing country. An international currency needs to assume the functions of being a medium of exchange, a store of value, and a unit of account. A currency can be regarded as an international currency in a real sense only if it has all three functions.

Since 2003, RMB internationalization has moved forward amid twists and turns. Among the three basic functions, the RMB’s function as a medium of exchange has developed relatively fast, followed by the function as a store of value, and finally the function as a unit of account. During 2003–2009, the RMB was in the initial stage of internationalization. During this period, cross-border trade started to be denominated and settled in RMB, the RMB business kicked off in Hong Kong SAR and Macao SAR, and China Development Bank issued RMB bonds for the first time in Hong Kong SAR in 2007.

In 2009–2015, the internationalization of the RMB accelerated. China facilitated the settlement of cross-border trade and direct investment in the RMB by launching and expanding pilot programs. Regarding cross-border investment, schemes such as RMB Qualified Foreign Institutional Investors (RQFII), RMB Qualified Domestic Institutional Investors (RQDII), and Shanghai-Hong Kong Stock Connect were introduced. In addition, measures were taken to relax restrictions on cross-border RMB loans and trade financing. The offshore RMB market, as represented by Hong Kong SAR, grew rapidly. The People’s Bank of China (PBoC) started to provide RMB overseas via bilateral local currency swaps. In 2015, the International Monetary Fund (IMF) decided to include the RMB in the Special Drawing Rights (SDR) basket, and the Cross-border Interbank Payment System (CIPS) started operation.

After the exchange rate reform in 2015, the RMB exchange rate fluctuated sharply and the pace of RMB internationalization slowed. As China’s economic condition improved in 2017 and capital outflow pressure eased, the process of RMB internationalization continued to accelerate steadily. After 2017, Bond Connect and RMB-denominated crude oil futures were launched; MSCI, FTSE Russell, and S&P Dow Jones announced the inclusion of A-shares in their index systems; and the opening-up of China’s domestic financial sector accelerated further. Since 2020, the pace of RMB internationalization has accelerated again, with bilateral local currency settlement being a bright spot (Fig. 6.1).

Fig. 6.1

Source PBOC, IMF, SWIFT, Chinn & Frankel (2007),Footnote

Chinn, M., & Frankel, J. A. (2007). Will the euro eventually surpass the dollar as leading international reserve currency? In G7 Current account imbalances: sustainability and adjustment (pp. 283–338). University of Chicago Press.

CICC Research

Overview of RMB internationalization. Note SDR stands for Special Drawing Rights.

However, the level of RMB internationalization is still disproportionate to the large size of China’s economy (with potential for widening), which remains a key issue. Despite the US’s share of global GDP falling from 30% in 2000 to 24% in 2021 while China’s share rose sharply from 4 to 18% over the same period, the current international monetary system is dominated by the USD. According to IMF statistics, as of 2022, the USD’s dominant position in global foreign exchange reserves has remained solid. The USD accounts for 58% of global foreign exchange reserves, followed by the EUR (20%), the JPY (6%), and the GBP (5%). The RMB ranks fifth with a share of about 3%.

In addition, the development of the RMB as a medium of exchange and a unit of account clearly lags behind China’s position in global trade. China has become the world’s largest trading country, accounting for 12.5% of total global trade in 2022, whereas the RMB’s share of international payments as a settlement currency was only 2.15%. In contrast, about 65% of international debts, 55% of international loans, and 80–90% of global commodity trade were denominated in USD in the same year.

6.2 A Win–Win for Internationalization and the BRI

To realize internationalization, a currency needs to have a complete closed loop of cross-border investment and financing. We believe the RMB’s primary hurdle to fully assuming the role of international currency is that such a closed loop has not yet been formed for the RMB. In a complete closed-loop of cross-border investment and financing, business entities would be willing to raise funds and have relatively easy access to RMB financing through channels such as bond issuance and bank loans, and RMB holders would have the channels to use the currency to buy goods or invest in financial products. The RMB has long faced constraints on both the investment and financing sides. As the RMB was a high-interest currency for much of its history, it naturally lacks competitive advantages on the financing side. However, this situation changed in 2022–2023, and the financing cost of the RMB has fallen notably relative to the USD as the US has been in the most aggressive rate-hike cycle in four decades. On the investment side, the types and proportion of commodities denominated and settled in RMB are still relatively limited.

The mismatch between the international status of the RMB and China’s share of the global economy and trade has been undergoing changes. The BRI brings an opportunity to facilitate RMB internationalization, which can facilitate investment, financing, and trade cooperation among BRI countries; increase two-way interaction; and create a virtuous cycle. We expect RMB internationalization and BRI development to create a win–win situation, driving an effective breakthrough in promoting the use of the RMB as an invoicing currency and a settlement currency. After the outbreak of the Russia-Ukraine conflict, the three functions of international reserve currencies—e.g., a medium of exchange, a store of value, and a unit of account—have been separated. As a result, we believe it has become more possible for a currency to develop the function as a unit of account and a medium of exchange first, and then as a reserve of value. We expect the RMB to be presented with greater opportunities in developing the functions as a medium of exchange and a unit of account.

6.2.1 Large Trade Volume and the Trade Network Are Favorable to Expanding the Use of the RMB in Trade Settlement

One of China’s greatest advantages in promoting RMB internationalization is its large trade volume. China has a trade surplus with BRI countries as a whole, and their trade is highly complementary. Since the introduction of the BRI in 2013, China and BRI countries have strengthened trade cooperation and lowered trade barriers through the establishment of free trade zones and economic cooperation zones, and the value of trade between China and BRI countries has continued to grow. The proportion of BRI countries in China’s trade value increased from 39.1% in 2013 to 42.2% in 2021. BRI countries rely heavily on energy for economic development, exporting raw materials and intermediate goods to China. Furthermore, China has a well-developed manufacturing industry chain and exports capital goods, transportation equipment, and consumer goods to its BRI partners. Research shows that² China and BRI countries are building an increasingly extensive trade network.

Trade cooperation creates demand for currency cooperation. China’s trade surplus with BRI countries means that the latter have RMB financing demand, and the mutually complementary trade structures of the two parties can promote the formation of a closed loop of RMB investment and financing. The signing of free trade agreements can effectively reduce the level of tariffs between China and BRI countries. As trade flows increase, the RMB can expand its role as a settlement currency, boding well for the wider use of the RMB.

To date, the PBoC has signed bilateral trade swap agreements with central banks of a number of BRI countries, allowing the latter to inject RMB funds into their financial systems and facilitate their domestic companies or institutions’ access to RMB financing to pay for imports from China. The use of RMB can help lessen the risk of using third-party currencies for settlement and facilitating trade activities. For example, if BRI countries can directly use RMB as the settlement currency for trade, financial, and investment activities, it could help streamline the procedures of transactions, reduce transaction costs, avoid the negative impact of third-party exchange rate fluctuations on trade, and promote the development of intra-regional trade and finance. Against such a background, countries have naturally turned to diversifying their foreign exchange reserves and increasing the use of local currencies for settlement, which could help them reduce the dependence of their financial systems on other countries and lessen attendant risks.

6.2.2 China’s Industry Chain Advantages Facilitate Development of the RMB as an Invoicing Currency

China has advantages in industry chain over BRI countries, which is favorable to the development of the RMB as an invoicing currency. If a country exports goods with high technological content and value added, it usually has stronger bargaining power and is more capable of driving trade activities denominated in its own currency.³ Studies show that from the industry chain perspective, China plays an important role in BRI countries, and has dominated the industry chains of textile and high-tech manufacturing sectors.⁴ China is ahead of most BRI countries in terms of manufacturing and strategic emerging industries, especially high-end manufacturing fields such as artificial intelligence (AI), high-speed rail, nuclear power, and aerospace. The levels of economic and industrial development vary among BRI countries, covering almost every stage of industrialization. Different BRI countries have various advantageous industries. China and BRI countries are mutually complementary in advantageous industries, and China can address their needs for equipment, technologies, and capital.

6.2.3 China Can Leverage Its Financial Markets to Make RMB Reserves More Attractive

Compared with BRI countries, China has a large and relatively open financial market. China has gradually opened its capital account since the 1990s under the principle of prioritizing inflows over outflows, long-term funds over short-term funds, direct investment over indirect investment, and institutions over individuals. Specifically, China opened direct investment first, followed by securities investment and then other investments.

China launched the Qualified Foreign Institutional Investors (QFII) program in 2002, after which foreign capital entered the country’s capital market. Since 2005, both China’s current account and capital account have continued to record large surpluses. China reformed its exchange rate formation mechanism to encourage orderly capital outflows and facilitate balance-of-payments equilibrium, and shifted its foreign exchange management from “liberal influx and stringent outflow” to “two-way balanced management”. The Qualified Domestic Institutional Investors (QDII) system was introduced in 2006, allowing domestic investors to invest in overseas securities markets. In 2009, the pilot program of RMB settlement for cross-border trade was launched, marking an acceleration in RMB internationalization. Subsequently, China rapidly improved the facilitation of cross-border RMB flows under the current account and capital account through the RQFII and RQDII schemes. China announced the start of the Shanghai-Hong Kong Stock Connect pilot program in 2014, the Shenzhen-Hong Kong Stock Connect program in 2016, and the Bond Connect program in 2017. Restrictions on QFII and RQFII investment quotas were lifted in 2019, and the Swap Connect program was officially launched in 2023.

We believe China has large room for economic development and its economy has been growing at a fast pace, supported by sound fiscal and monetary policies and continued opening-up of financial markets. As RMB assets are liquid and can deliver relatively stable comprehensive returns, they are attractive to investors in BRI countries. Overall, stocks and bonds in the domestic financial market are the main types of RMB financial assets held by overseas market entities. As of end-2022, total RMB financial assets held by overseas investors was Rmb9.6 trn, of which stocks, bonds, loans, and deposits accounted for 33%, 36%, 13%, and 18%, according to the PBoC.

6.2.4 China Can Promote RMB Financing Through Infrastructure Construction

Among the five main goals of the BRI (namely policy coordination, infrastructure connectivity, unimpeded trade, financial integration, and closer people-to-people ties), infrastructure connectivity is at the core, with infrastructure construction laying a foundation for strengthening cooperation under the BRI.⁵ According to data from the Ministry of Commerce, from 2013 to 2021, China signed US $1.1 trn of new contracts with BRI countries for projects under the BRI framework, accounting for about 51% of its total new contracts for foreign projects. Infrastructure construction enhances economic growth potential and improves people’s living standards, but it is a public good accompanied with high investment amounts, long construction periods, and limited direct economic benefits, to some extent. To meet the large-scale and long-term investment demand in infrastructure, it is necessary for BRI countries to build stable and sustainable financial support systems. We believe that China can promote RMB financing through infrastructure construction in BRI countries, by leveraging its advantage in engineering, and making use of financial institutions such as the Asian Infrastructure Investment Bank (AIIB) (Fig. 6.2).

Fig. 6.2

Source Sebastian Horn, Carmen M. Reinhart & Christoph Trebesch, “China’s Overseas Lending”, NBER, CICC Research Department

Characteristics of China’s overseas loans. Note The data sample in the chart is China’s overseas loans from 2000 to 2017.

6.3 Choice of Paths: How to Promote Currency Internationalization?

From historical experience, there are two typical models of currency internationalization. The first is the German model, which features the dominance of real economy trade and support from finance; the second is the Japanese model, in which finance plays a major role. If we use the share of global official foreign exchange reserves as a proxy measure of the level of currency internationalization, the internationalization of the Deutsche mark (DEM) was more successful than that of the Japanese yen (JPY). Comparing the typical models of internationalization of the two currencies, and given the current macroeconomic landscape of deglobalization and definancialization, we believe the path to DEM internationalization on the back of its trade advantages and regional cooperation is more valuable as a reference for RMB internationalization.

6.3.1 The German Model: Denomination of Trade Plus Capital Control

In the 1950s, Ludwig Wilhelm Erhard, then West German Economics Minister, advocated free competition and market forces. He introduced a number of policies, including monetary reform and trade liberalization. Over this decade, West Germany’s GDP grew at an annualized rate of 7.5%. The rapid growth in exports resulted in a large current account surplus. In 1952, West Germany began to gradually relax foreign exchange controls and in 1958, it officially realized current account convertibility. At the same time, the Bundesbank adopted a monetary policy with the primary objective of ensuring price stability, and it used monetary policy tools such as interest rate control and deposit reserves to maintain the stability of the DEM’s value. However, at that stage, West Germany had not yet opened its financial market to the outside world, and capital inflows and non-trade payments remained limited.

From the 1960s to the 1980s, the proportion of the DEM in trade settlements and international reserves increased rapidly. Due to West Germany’s deregulation of its exchange rate, large international capital inflows also exerted inflationary pressure on the country, with the inflation rate rapidly climbing from around 2 to 7% over 1969–1974. In response, the West German government adopted a proactive and flexible policy. It underwent a repeated process of “tightening, lifting, and reinstating restrictions” on capital inflows. The DEM exchange rate system also underwent an evolution to a fixed exchange rate, floating exchange rate, and the establishment of the European Monetary System (EMS), which effectively reduced the impact of exchange rate appreciation on the domestic economy and trade.

Since the 1980s, the internationalization of global financial markets has gradually stepped up, and capital markets in Tokyo, London, New York, and Hong Kong SAR have continued to expand. West Germany shifted from its previous attitude of financial repression and began to accelerate the development of its financial market and relax financial regulations. In 1984, West Germany achieved capital account convertibility. The European monetary system gradually became pegged to the DEM, while West Germany assumed responsibility for stabilizing the DEM against the USD.

In general, Germany’s model of currency internationalization is backed by strong manufacturing industries, with trade under its current account as the core driving force. Underpinned by the achievements of European economic integration, the DEM gradually became the currency for regional trade settlement and foreign exchange interventions through stable currency value and capital control.

6.3.2 The Japanese Model: Insulated Financial Liberalization Plus Offshore Market

In April 1964, Japan lifted exchange restrictions related to receipts and payments in the current account. In February 1973, it adopted a floating exchange rate system, and the volatility of the JPY began to increase. To cope with exchange rate risk exposure, the Japanese government promoted the settlement of exports in JPY, marking the start of JPY internationalization.

In the 1980s, the Japanese government began to implement the strategy of JPY internationalization, and the JPY achieved current account convertibility and then capital account liberalization. In December 1980, Japan promulgated a thoroughly revised Foreign Exchange and Foreign Trade Control Law,⁶ which lifted the previous restrictions on foreign exchange, marking Japan’s move towards capital account convertibility and driving a substantial increase in financial transactions denominated and settled in JPY. Subsequently, Japan’s financial liberalization reform began to accelerate. In May 1984, as the trade imbalance between Japan and the US increased, the US asked Japan to accelerate financial liberalization and the internationalization of the JPY. The Japanese government released a report, Current Status and Prospects for Financial Liberalization and the Internationalization of the Yen, which involved improvement in a number of measures to step up the internationalization of the JPY, including the establishment of Japan’s offshore market, relaxation of financial regulations, and permission of foreign bank branches in Japan to operate the Euroyen (offshore yen) deposit business in Japan.⁷ The Japan Offshore Market (JOM) was officially established on December 1, 1986. With the rapid progress of the internationalization of the JPY, the currency appreciated sharply driven by inflows of international capital. As a result, the Japanese government started to worry about the decline in the competitiveness of its exports.

To drive economic growth, the Japanese government implemented a policy of low interest rates and loose liquidity to detach asset prices from their real value. In the late 1990s, due to the collapse of the bubble economy and the impact of long-term economic stagnation, the internationalization of the JPY came to a standstill. After 1990, the JPY’s share of international reserves declined from a high of 10% to only 3% in 2006, and has remained at a relatively low level since then.

In general, the Japanese model relies on the currency internationalization strategy and the implementation of financial liberalization policies with the opening of offshore markets at the core. However, the internationalization of the JPY was dragged by the slow pace of onshore market reform and the lack of regional monetary and financial cooperation.

6.3.3 Implications of the Paths to RMB Internationalization

First, competitiveness in trade is at the core of currency internationalization, and changes in the macroeconomic environment such as deglobalization and definancialization highlight the necessity of advancing RMB internationalization via the current account. The paths to internationalization of the DEM and JPY were both based on the real trade settlement demand brought about by the growth in the two countries’ economies and trade. The export channel of the DEM was based on the global goods production and trade network with products made in West Germany at the core. The DEM was the dominant means of payment and clearing, laying a foundation for its sizable international demand. As for Japan, the country’s position and bargaining power in the global industry chain were relatively weak. Therefore, Japan encouraged domestic and overseas financial institutions to participate in the trading of JPY assets mainly by liberalizing capital controls and “exporting” JPY through financial channels. The internationalization of the RMB in BRI countries can rely on China’s trade and industry chain advantages, with a focus on the use of RMB as a settlement and invoicing currency for cross-border trade.

Second, in the early stages of currency internationalization, efforts should be made to coordinate interest rate liberalization, exchange rate liberalization, and capital account convertibility. However, the opening of financial markets or lifting of capital controls are not prerequisites for currency internationalization, and the competitiveness of real trade may be more important in the early stages of internationalization, in our opinion. In the 1980s, although Japan’s financial market was more open than West Germany’s, it lacked support from the real economy’s commodity trading in the international market. By contrast, West Germany was more cautious about the opening of its capital account and experienced a flexible, gradual process of tightening, lifting, and reinstating regulations. West Germany chose the path of opening up capital outflows first and then capital inflows later.

We believe the opening-up of financial markets or the lifting of capital controls are not a necessary condition for the internationalization of the RMB. In the early stages of RMB internationalization, a faster pace of capital account opening than interest rate and exchange rate reforms may incur risks. However, from a longer-term perspective, capital controls and incomplete currency convertibility may hinder cross-border flows of local currencies, thus affecting the speed and extent of internationalization. In the medium and long term, China may consider gradually relaxing financial regulations and giving full play to the role of financial markets under the BRI framework.

Third, regional cooperation is an effective means to achieving currency internationalization. The successful internationalization of the DEM also benefited from the political and institutional arrangements among European countries. With the goal of promoting trade and investment facilitation and European economic and monetary integration, West Germany leveraged the development of intra-European trade, especially the establishment of the EMS in March 1979, to support the development of the DEM into a key regional currency, laying the foundation for the birth of the EUR in 1999. For China, the BRI aims to strengthen close cooperation and connectivity in various fields among BRI countries, increase the scale of intra-regional trade and investment activities, and improve the openness of countries in the region, thus providing an opportunity for the wide use of the RMB in the regional economy.

In conclusion, we believe the path to DEM internationalization on the back of its trade advantages and regional cooperation is a more valuable reference for RMB internationalization. According to the German and Japanese experience, free convertibility under the capital account is not a precondition in the early stages of RMB internationalization, and faster capital account opening than interest rate and exchange rate reforms may incur risks instead. Changes in the macroeconomic environment (i.e., deglobalization and definancialization) have further highlighted the necessity and importance of promoting RMB internationalization through the current account. To promote RMB internationalization, more attention can be paid to the competitiveness of the real economy and technological innovation, and efforts can be made to facilitate cooperation between China and BRI countries in payment and finance, with a focus on partnerships in trade and real economic investment, in our view.

6.4 Three Focuses in Promoting RMB Internationalization

Taking into account the characteristics of BRI countries and drawing on the German and Japanese experience in promoting currency internationalization, we believe China can give full play to its competitive advantages in economic size and trade volume. First, it can seek breakthroughs in promoting the use of the RMB as a settlement currency and an invoicing currency for cross-border trade in BRI countries. On this basis, it can promote the use of the RMB as a store of value by driving the development and opening up of China’s financial markets, launching more RMB-denominated products, and building a closed loop of RMB investment and financing. To be specific, we believe there are three practical measures that China can adopt to promote RMB internationalization.

6.4.1 Bilateral Currency Swap Agreements and BRI Finance

Bilateral local currency swap agreements signed between the PBoC and foreign central banks have two main functions. The first is establishing a liquidity replenishment mechanism for BRI countries: Compared with bilateral swap agreements of developed countries, China’s bilateral swap agreements cover more developing countries, especially BRI countries. The second is facilitating trade and investment between China and BRI countries: Under such agreements, overseas central banks can provide RMB financing to domestic commercial banks and enterprises by using currency swap quotas to address demand for RMB imports and direct investment.

After the PBoC signed a Rmb180 bn bilateral local currency swap agreement with the Bank of Korea in 2008, it had signed bilateral currency swap agreements with central banks or monetary authorities in 40 countries and regions as of end-2021. The quota of the agreements has increased notably since 2018, with the total amount rising from Rmb3.02 trn in 2018 to Rmb4.02 trn in 2022, and the effective amount at Rmb3.54 trn (the difference between the total amount and the effective amount is the amount that had not been renewed and, thus, expired). In particular, China has signed bilateral currency swap agreements with 22 BRI countries, which has played a positive role in promoting bilateral trade and investment between China and BRI countries.

The signing of bilateral currency swap agreements can promote the use of the RMB. As of end-2022, overseas monetary authorities utilized a total of Rmb88.78 bn under bilateral currency swap agreements with the PBOC. Under these agreements, central banks of multiple countries—including South Korea, Russia, Mongolia, Türkiye, and Argentina—have used RMB to pay for imports from China, investment and financing, and to address liquidity needs to stabilize the foreign exchange market. The balance of RMB utilized by overseas monetary authorities increased to Rmb88.78 bn at end-2022 from Rmb15.80 bn at end-2014. In particular, the balance has increased rapidly since end-2020 amid growing international demand for the RMB. By signing bilateral currency swaps, the two parties can avoid potential losses caused by exchange rate fluctuations, which will help reduce their dependence on the USD and facilitate the internationalization of their own currencies.

Bilateral currency swap agreements signed between the PBoC and overseas central banks can help establish a liquidity replenishment mechanism. Research on central bank currency swap agreements⁸ shows that as a form of international lender of last resort, central bank swap lines have a significant impact on a country’s foreign currency financing cost. When swap lines provide liquidity support to overseas countries, the deviation between the pricing of their foreign exchange forwards and the theoretical value of covered interest parity (CIP) will narrow significantly, and the premium to be paid for foreign currency financing on behalf of the country’s financial system will decline.

We believe China’s bilateral swap agreement can provide a good liquidity replenishment mechanism for BRI countries that are in urgent need of foreign currency liquidity, although the long-term effect might not be highly visible at present. The existence of such mechanisms and related practices indicates that the bilateral currency swap agreements signed by China and other countries have become an important supplement to the existing international liquidity arrangements.

Nevertheless, there are still restrictions on the use of bilateral currency swap lines, one of which is that the mechanism for the use of bilateral local currency swap lines has not been clarified. At present, the actual amount of swap funds being used remains small compared with the total size of the agreements, and the use scenarios remain limited. According to recent practices, the main scenario for the use of local currency swap funds is cross-border trade settlement, yet the swap lines have played a limited role in helping BRI countries establish financial safety nets. As the main source of demand for local currency financing, BRI countries seldom use swap lines to meet cross-border investment demand. To address this issue, China could improve its regular mechanisms (i.e., explicit regulations on the quota, currency, quotation, and threshold) related to bilateral local currency swaps. These may help enhancing the understanding of swap agreements by commercial banks and enterprises, making it easier for them to use the swap lines.

6.4.2 Improving Bilateral Foreign Exchange Markets in BRI Countries

China has close economic and trade ties with BRI countries, but related activities are mostly settled in USD. This is mainly due to the well-developed supporting financial services, high level of convenience in financing, and relatively low cost of foreign exchange transactions in relation to the USD.

The USD shows advantages in risk reduction, transaction costs, and potential investment returns. Figure 6.3 shows the bid and ask prices for currency pairs at large banks in Thailand and Indonesia on April 12, 2023. For Bangkok Bank, the largest bank by assets in Thailand, the bid-ask spread for THB/USD was only 0.88%, and the transaction cost was less than half that for other major currencies. In contrast, the bid-ask spread for THB/CNY reached 3.17%. Data from Bank Mandiri, Indonesia’s largest bank by assets, also shows that USD has the lowest transaction costs.

Fig. 6.3

Source Bangkok Bank of Thailand, Bank Mandiri of Indonesia, CICC Research

Foreign exchange quotes at Bangkok Bank in Thailand and Bank Mandiri in Indonesia (April 12, 2023).

An important reason for the relatively high cost of currency exchange between the RMB and local currencies of BRI countries is that their bilateral foreign exchange market remains underdeveloped, or no direct currency exchange markets have taken shape. Therefore, the USD continues to be used as the medium currency for the currency exchange between the RMB and local currencies. For example, the transaction cost of THB/CNY is more than twice that of THB/USD, and the bid-ask spread for THB/CNY is twice the spread for THB/USD. When the cost of transactions between the RMB and the local currency is high, trade contracts denominated in USD become a conventional option for the two parties to share the exchange rate risk.

To solve the problem of high transaction costs, we believe it is increasingly important to build and improve bilateral foreign exchange markets between China and BRI countries. A well-functioning foreign exchange market with better liquidity for direct bilateral local currency transactions can help China and BRI countries achieve direct conversion without using third-party currencies in foreign exchange transactions. Such a move can shorten the time and reduce the cost needed for indirect transactions with the USD as the intermediary, and avoid the exchange rate risk caused by fluctuations in the USD and the shortage of liquidity in the international foreign exchange market, thereby promoting the use of the RMB in international trade transactions.

Regarding the development of the onshore RMB foreign exchange rate market, the China Foreign Exchange Trade System launched direct RMB-MYR trading in the interbank foreign exchange market in 2010 under the market-making mechanism, the same as that for CNY/USD. Since then, the China Foreign Exchange Trade System has launched direct transactions between the RMB and 21 non-USD currencies. Such transactions reached around Rmb2.2 trn in 2022, with their share of the total value of direct transactions hovering between 3.6 and 4.2% in recent years. Among the above-mentioned non-USD currencies, 11 are from BRI countries (or regions), with annual transaction value at about Rmb100 bn before 2022, accounting for about 1–2% of China’s bilateral trade with the corresponding countries.

To facilitate the development of the BRI, offer financial support for the development of the real economy, and facilitate the development of the inter-bank RMB foreign exchange direct transaction market, the China Foreign Exchange Trade System decided to waive fees associated with bid and ask prices in direct trading among the RMB and 10 foreign currencies—i.e., Singapore dollar, Russia ruble, Malaysian ringgit, New Zealand dollar, South African rand, Saudi riyal, UAE dirham, Polish zloty, Hungarian forint, and Turkish lira—for three years starting August 1, 2017.⁹ In 2020,¹⁰ besides the above-mentioned 10 currencies, the South Korean won as well as Thai baht were also included in the scheme.

Regarding the development of the offshore RMB foreign exchange market, the Chinese mainland and Hong Kong SAR signed the Memorandum of Understanding in 2004, marking the official launch of the offshore RMB market. Since then, by leveraging the financial market platform in Hong Kong SAR and the development of infrastructure (i.e., cross-border RMB clearing and payment), the offshore RMB foreign exchange market has gradually developed into an emerging force in the global foreign exchange market. In many countries, offshore RMB sees strong demand and has good liquidity in the local foreign exchange markets thanks to the increase in China’s share of global trade, the gradual opening-up of China’s capital account, and the development of bilateral foreign exchange markets.

By 2022, RMB became the fifth most traded currency in the world in terms of foreign exchange turnover, second only to established currencies such as the USD, EUR, JPY, and GBP. Recently, with the gradual increase in the number of participants in the CIPS system and the implementation of emerging functions such as the Multi-Central Bank Digital Currency (CBDC) Bridge platform, the transactions and use of RMB in the local markets of BRI countries have become more convenient.

At the same time, the development of the RMB foreign exchange market faces challenges on multiple fronts, in our view:

• (1) The infrastructure of the foreign exchange market remains inadequate. Some BRI countries have immature financial markets and inadequate foreign exchange market infrastructure, trading systems, and clearing and settlement mechanisms.

• (2) The opening up of financial markets still has upside. The financial markets in some BRI countries are not fully opened, and restrictions imposed on foreign investment may affect the cooperation between China and these countries in building bilateral foreign exchange markets and hinder the expansion of direct transactions between the currencies of the two parties.

• (3) Supporting services still have room for improvement. The financial markets of some BRI countries are underdeveloped and are characterized by relatively weak risk management capabilities. The market for direct transactions between the RMB and local currencies might lag in terms of supporting services.

• (4) Difficulties in coordinating among policies of various countries. Coordination among relevant policies in different countries is challenging due to the notable differences in the levels of economic development, monetary policies, and financial regulatory policies of different countries.

6.4.3 Promoting the Use of RMB as an Invoicing and Settlement Currency for Commodity Trade in BRI Countries

RMB has opportunities to improve its payment and invoicing functions. Barry Eichengreen (2010)¹¹ believes that the internationalization of a country’s currency should undergo the following three stages: (1) Encouraging the use of the currency as an invoicing and settlement currency in trade activities; (2) promoting the use of the currency in private financial transactions; and (3) incentivizing central banks and governments to hold the currency as foreign exchange reserves. Based on this framework, we believe that promoting RMB settlement for bilateral trade between China and BRI countries by leveraging China’s advantages in trade and industry chain could improve the RMB’s functions as a medium of exchange and a unit of account. According to the traditional international trade theory, the choice of currency as a unit of account for trade activities is related to the transmission of exchange rates. That is to say, trade activities can be denominated in either the currency of the producing country or that of the consuming country.

Changes in the global landscape have provided opportunities for the RMB to play a bigger role in trade settlement and invoicing. Many emerging BRI countries are seeking to reduce their reliance on a single currency for settlement and invoicing. By leveraging China’s extensive trade network and relatively sound infrastructures (i.e., for payment, clearing, and foreign exchange transactions), the RMB has become an important choice for many countries in trade settlement and invoicing.

As most BRI countries are resource-rich, we suggest focusing on commodities in the process of promoting the use of the RMB as an invoicing and settlement currency in the trade of goods. First, China has strong demand for the imports of commodities, and promoting RMB settlement of commodities can help the partner countries develop RMB reserves to a certain extent, thereby enhancing the function of the RMB as a store of value. Second, commodities-rich countries are in the upstream of the value chain, and their choices of invoicing and settlement currencies might be less affected by the currencies used for settlement and invoicing in the upstream and downstream of the value chain.

Promoting the use of the RMB as an invoicing and settlement currency requires striking a balance between efficiency and economic interests. We believe BRI countries need to meet certain conditions such as abundant natural resources, a local economy that is mutually complementary to China’s economy, and close bilateral trade with China. Under the premise that the above-mentioned basic conditions are met, different RMB circulation systems can be developed according to the trade relationship between China and the counterparty. Specifically, when a country has a trade surplus with China, the RMB can be exported to the country through the current account, and it can return the RMB to the domestic market or flow into the offshore RMB market through the capital account. When a country is in a trade deficit with China, China can invest the RMB in the country in the form of direct investment, securities investment, and other capital account items.

In our view, priority could be given to promoting the use of the RMB as a settlement currency in countries with natural resources as their main exports (more than 50%), large bilateral trade volume with China (more than US$10bn), and a high proportion of bilateral trade with China in total imports and exports (more than 9%). Under the trend of economic globalization over the years, some countries’ exports are dominated by commodities as they are relatively rich in agricultural products, energy, or mineral resources. In addition, these countries are usually characterized as having ample room for economic development and a relatively low level of industrialization. As the world’s largest manufacturing country, China can meet its economic needs by exporting manufactured goods and other products. Coupled with the fact that China is the world’s largest importer of commodities, it can develop a mutually complementary relationship with these resource-rich countries through bilateral trade (Fig. 6.4).

Fig. 6.4

Source World Bank, General Administration of Customs of China, Wind, CICC Research

Countries with favorable economic conditions for promoting the use of RMB in commodity settlement and invoicing. Note We use 2021 data in the figure; data on total trade by country comes from World Bank; data on trade with China comes from General Administration of Customs of China.

Settlement currency refers to the currency used to pay for goods and services, while invoicing currency is that used to mark or set prices in transactions. Although the settlement currency and the invoicing currency tend to be the same in most cases, the levels of difficulty in using the RMB as an invoicing currency can vary among different types of commodities (as commodity pricing is market-based to a large extent). For commodities that feature limited use of the USD as an invoicing currency and active trading on domestic exchanges, measures could be taken to promote the use of the RMB as a settlement currency and an invoicing currency simultaneously, in our view. Regarding commodities for which the USD enjoys strong first-mover advantages as an invoicing currency (i.e., oil and gas), efforts could be made to promote the use of the RMB as a settlement currency first, and then as an invoicing currency later.

The RMB has made significant progress as a settlement currency for commodities in recent years. In particular, cross-border RMB settlement in the field of commodities trading witnessed rapid growth. According to the 2022 RMB Internationalization Report released by the PBoC, cross-border RMB receipts and payments in the commodity trade field maintained rapid growth in 2021. Cross-border RMB settlement for trade in major commodities (i.e., crude oil, iron ore, copper, and soybeans) reached Rmb405.47 bn, a YoY increase of 42.8%. Cross-border RMB settlement for trade in new energy metals (i.e., lithium, cobalt, and rare earths) totaled Rmb100.56 bn, a YoY increase of 27.7%. In 2021, trading of the seven specified varieties of futures listed in China—namely, crude oil, iron ore, purified terephthalic acid (PTA), TSR 20, low-sulfur fuel oil, international copper, and palm oil—developed steadily and played a role in providing benchmarks for invoicing and settlement of commodity trading in RMB.

Countries’ willingness to advance the use of the RMB as a settlement and invoicing currency has increased. In the energy market, China completed its first purchase of liquefied natural gas (LNG) using cross-border RMB settlement¹² on March 28, 2023, marking a key step toward promoting RMB settlement in oil and gas trading in the commodity market. Specifically, China National Offshore Oil Corporation (CNOOC) purchased a shipment of LNG from French-based Total Energies through Shanghai Petroleum and Natural Gas Exchange (SHPGX). The transaction volume was about 65,000 t, and the LNG was sourced from the United Arab Emirates. The transaction was conducted by a Chinese exchange and settled in RMB, with services provided by a European energy company and resources sourced from a Middle Eastern country.

We believe endeavors to promote the use of the RMB as a settlement and invoicing currency for commodity trading with BRI countries still face considerable challenges. International futures exchanges are now dominated by European and US exchanges. For example, there are three major crude oil futures contracts in the world—West Texas Intermediate (WTI) on the Chicago Mercantile Exchange (CME), Brent Crude Oil on the Intercontinental Exchange, and DUBAI on the Dubai Mercantile Exchange. These contracts reflect crude oil supply and demand conditions in North America, Europe, and the Asia–Pacific region, and are denominated in USD.

China may continue to face a situation in which USD is the invoicing currency and RMB is the settlement currency, making it challenging for a breakthrough in developing the RMB as an invoicing currency. Therefore, the development of the RMB’s functions as an invoicing currency and settlement currency might not be simultaneous. A complete set of services such as commodity freight and insurance are denominated in USD, and its use as the invoicing currency is supported by well-developed exchange rate instruments as hedging tools. In the absence of pricing power, the use of the RMB as a settlement currency could still incur exchange rate risk.

6.5 Reflections and Insights

In addition to traditional fundamental factors—i.e., inflation, liquidity, and foreign trade volume—the choice of international currencies should also take into account the network effect. The more countries in which a currency is used, the more universal it becomes. Therefore, the international monetary system is characterized by strong inertia. Although China’s economy and trade volume are large enough, the use of the RMB in global trade settlement and foreign exchange transactions as a store of value and in other important dimensions still lags significantly behind. The evolution of international monetary choice usually requires shocks from major economic and social events to break the original inertia.

In the current era of deglobalization and definancialization, the foundation of the USD as the dominant global currency has faced shocks to some extent, and the shortcomings of the USD monetary system have been gradually magnified, in our opinion. Due to changes in the global economic and political environment, we believe the international monetary system is transitioning from a USD-dominated system to a more pluralistic one. Global events such as the COVID-19 pandemic and the Russia-Ukraine conflict have increased the need for currency diversification. These changes in the global landscape have presented historical opportunities for the internationalization of the RMB, in our view, and the international use of the RMB proportionate to China’s share of the global economy and trade share may become an important development trend in the next stage.

China has extensive economic and trade ties with BRI countries. Against the background of ongoing deglobalization, many BRI countries may also need to reduce their reliance on the USD in an appropriate manner. Therefore, the rise in the level of RMB internationalization can also work to facilitate the high-quality development of the BRI. By analyzing the historical experience in currency internationalization in Germany and Japan, we find that the internationalization path of the DEM on the back of the country’s competitive advantages in trade and regional cooperation provides an important reference for China to promote the internationalization of the RMB in BRI countries.

For China, competitiveness in trade is at the core of currency internationalization. Advancing RMB internationalization with a focus on current accounts and leveraging China’s advantages in trade and industry chains might be the most suitable choice for China against the backdrop of deglobalization and definancialization. Considering that China’s financial markets still have room for expansion in terms of depth and breadth, capital account opening is not a necessary condition in the early stage of monetary internationalization, while coordination can be taken to facilitate interest rate liberalization, exchange rate liberalization, and capital account convertibility.

In the context of partial convertibility of capital account, regional cooperation is an effective means for realizing currency internationalization. Political and institutional arrangements among European countries have played a positive role in driving the internationalization of the DEM. China has cultural commonality and close trade ties with many BRI countries, laying the foundation for regional cooperation and joint formulation of rules and arrangements for the use of the RMB.

In terms of specific measures to promote RMB internationalization in BRI countries, we believe three measures will play important roles: (1) The signing of bilateral currency swap agreements can promote the use of the RMB as a settlement currency; (2) the development of RMB-denominated commodity products could expand the use of the RMB as a invoicing currency; and (3) the development of foreign exchange markets is likely to strengthen the use of the RMB as a store of value. The signing of bilateral swap agreements is not only a liquidity replenishment mechanism that can help BRI countries reduce overall financing costs, but also a trade facilitation tool that creates a liquidity basis for bilateral trade settlement in the RMB. The establishment of a foreign exchange market in which the RMB directly trades with the local currencies of BRI countries can effectively reduce transaction costs and improve the efficiency of bilateral economic and trade transactions. Given that BRI countries are mostly resource-rich, we think the use of RMB for settlement and invoicing of commodity trade could become the starting point for promoting the use of RMB in trade settlement and invoicing.