Chapter 2 Current Situation of RMB Internationalization

As the second largest trading nation,China used USD,JPY and EUR as the settlement of currency for cross—border trades before RMB settlement was launched.Since the financial crisis,America carried out Quantitative Easing Policy twice and weakened USD to promote the exports and cut down the trade deficit,causing the currency value of USD all the way down.On the other hand,since the Japanese government's zero—interest rate policy in 1990s,frequent,large—scale JPY arbitrage operation has established JPY as one of the currencies with the biggest fluctuation.The increasingly serious sovereign debt crisis greatly discouraged people's confidence towards EUR and to keep the crisis from spreading,European Central Bank carried out the policy similar to America's QE,causing the EUR to depreciate as well.In the meantime,the unsteadiness in North Africa and Middle East has resulted in the volatility in oil price.All the factors have contributed to the uncertainty and complexity of world's economy,with the main currencies’ exchange rates volatile and unpredictable.If still using the main currency as trade settlement,our country's foreign trade enterprises would be hurt by the cost and revenue's uncertainty caused by exchange rate.Furthermore,the enterprises that provide services to the foreign trade enterprises would also be affected,endangering the stable development of our national economy.

Since financial crisis with the down—turn economy and low demands of China's imports,the 2011 American and European trades among the China's total trade amount dropped from 12.6% and 16.4%.China's foreign trade structure has changed a lot and the multinational tendency has strengthened.ASEAN and BRICKs have become more and more important trade partners of China with the ratio among China's trade amount rising from 10.3% and 8% respectively.Under such background,out of concerns around the exchange rate risk brought by devaluation and volatility of USD and JPY,China launched the cross—border trade RMB settlement.

2011 is the year when the external and internal macro economy fluctuated and also the year when RMB internationalization made great progress.With the RMB trade settlement spreading over the nation,the transaction amount has boosted,with the exchange market transaction active,RMB stock,bond and derivatives market enlarging and the global share increasing steadily.

Since 2008 China has successively signed the currency swap with 14 countries and regions,reaching the scale of 1 301.2 billion Yuan.Nigeria,Malaysia,South Korea,Cambodia,the Public of Belarus,Russia and Philippines have already included RMB as part of foreign exchange reserve.With the improvement of RMB recognition around the globe,the international reserve currency's function scope is expanding.

2.1 RMB cross—border trade settlement

Throughout the history of main currencies such as GBP,USD and JPY,internalization of a currency usually experiences three stages:being as trading currency,investment currency and finally international reserve currency.To improve the scope and ratio of RMB settlement is a fundamental step to the internationalization and also creates ideal environment for RMB's acting as international investment and reserve currency.It is what the core interest of RMB internationalization:to reduce or eliminate the exchange rate fluctuation risk that the national trades face.Therefore,the ratio of RMB cross—border trade settlement is one of the key indictors to describe the internationalization progress and to evaluate the degree of internationalization of RMB.

2.1.1 Characters of RMB cross—border trade settlement

Since the pilot in July 2009,the cross—border RMB transactions went smoothly and spread over the country till August 2011.Settling the current account by RMB promotes the convenience of trade and investment,attracting more and more enterprises to settle the trade by RMB.By the end of 2011,the valuation and settlement of international trade present four main characters as follows:

1.Multistage steady progress.

Cross—border trade settlement by RMB is a newly—born thing in our national trade field,which not only involves the national foreign trade enterprises,banks,custom,Commerce Department and Foreign Exchange Management Department,but its transaction development also needs the coordination and cooperation of the government,enterprises and financial markets.Experiences are accumulated in exploration and systems are improved all along.RMB cross—border trade settlement has went through three development phases:

Phase 1:Pilot in limited areas.In July 2009,365 enterprises in Shanghai,Guangzhou,Shenzhen,Zhuhai and Dongguan started the pilot program of RMB trade settlement.As China is the biggest trade partner in ASEAN,ASEAN is the fourth biggest trade partner of China after the European Union,America and Japan.Besides,most of the countries of ASEAN are influenced by Confucius culture and show high approval of Chinese economy and cult—ure.Therefore,the first pilot areas are set in Hong Kong—Macao area and ASEAN.

Phase 2:Enlarge the pilot areas.In June 2010,based on the fundamental of previous pilot experience,cross—border settlement pilot areas were enlarged from the above—mentioned four cities to 20 provinces (including autonomous regions and municipalities) and at the same time the foreign pilot areas from Hong Kong—Macao area and ASEAN to all the countries and regions in the world.The scope of business of RMB settlement pilot program includes cross—border goods trade,service trade and other current items.

Phase 3:Fully start the cross—border trade valuation and settlement by RMB.In August 2011,the cross—border RMB business areas enlarged in a further step,expanding to the whole country.Till then,any part and any enterprise in China can use RMB to settle the cross—border trade with any country in the world.

Figure 2—1 Monthly Sum of cross—border trade settlement by RMB

Source:The People's Bank of China,the Ministry of Commerce.

2.Scale expanding rapidly.

According to the statistics from the People's Bank of China,cross—border trades settled by RMB in banking industry has accumulated to 2 090 billion yuan,increasing 3.1 times of 506.41 billion yuan in 2010.The ratio of settlement by RMB amount to the total trade amount in China reaches to 8.9%,a great rise compared with 2.5% in 2010(Figure 2—1).

3.Goods trade settlement dominating.

In Chinese trade structure,the goods trade dominates and the situation is the same in cross—border RMB settlement.In cross—border RMB trade settlement structure from 2010 to 2011,the goods trade made up to 86.5% and 75.1% respectively (Figure 2—2) while the service trade and other current items made up to 13.5% and 24.9%.Though the service trade settlement of RMB has a small scale,it has a significant growth and rising tendency.

Figure 2—2 Bi—monthly settlement data of goods and service trades

Source:The People's Bank of China,the Ministry of Commerce.

4.Improvement in receipts and payment imbalance.

One main character of current international trade market is that the buy side takes domination.The importers possess the domination in determining trade conditions such as settlement currency and thus decide the selection of settlement currency.Therefore,among Chinese import trade,enterprises are more likely to choose settlement by RMB while in export trade,enterprises have to persuade the foreign import to accept RMB if they wish to settle in RMB,which takes longer time.What's more,it is rather difficult to change the customs of trade settlement.According to the data from the People's Bank of China,among the cross—border RMB goods trade amount,the amount of import trade settled by RMB takes up to 92% while the amount of export trade takes only 8%.The great gap between import and export settlement amount can be attributed to two reasons:Firstly,the cross—border trade RMB settlement is not fully extended.Secondly,there is a time gap for China's trade partners to accept the RMB trade settlement.Time and efforts are needed to win their credit.

In 2011,the situation of imbalance in settlement of RMB has improved with the ratio of RMB settlement of imports dropping to 78% and the ratio of exports rising to 22%.As is shown in Figure 2—3 monthly data,in the goods trade settlement items,the gap between exports settlement amount and imports settlement amount is narrowing.Up to December 2011,they are almost equal.In general,the imbalance situation of cross—border RMB settlement has significantly improved with the receipt—payment ratio rising from 1∶5.5 in 2010 to 1∶1.7.

Figure 2—3 Cross—border goods trade settled by RMB

Source:The People's Bank of China,the Ministry of Commerce.

Deep in the foreign trade settled by RMB,the RMB settlement amount among imports and exports arrived 404.84 billion and 1 221.9 billion yuan in 2010 and 2011 respectively,which took 4.3% and 10.9% among the total imports amount with a growth rate of 1.5 times.The simultaneous exports trade settled by RMB reached 33.27 billion and 349.86 billion yuan,which took 0.3% and 2.9% among the total exports amount with a growth rate of 8.7 times.The growth rate in 2011 RMB settlement in export trades went far beyond the sum in import trades.

It is worth concerned that the growth momentum of Import Trade RMB Settlement unexpectedly revised to decrease from 115.46 billion in August to 68.77 billion in December of 2011, which contrasted sharply with the rapid growth of Export Trade RMB Settlement (Figure 2—4). The Export Trade RMB Settlement had a monthly rising of 51.6% in 2011.

Figure 2—4 Ratio of RMB settlement in import and export trades

Source:The People's Bank of China,the Ministry of Commerce.

The reason is that the USD rebounds owing to the lower demand of RMB with its appreciation.Since June 2011,the international society surged a wave of shorting China from the Wall Street.The market is suspicious about whe—ther European Union can arrive at effective bail—out mechanism and thus USD became a sought after objects in the market as a haven currency.The motives for holding currency based on the predictions of RMB appreciation weakened and the demand of RMB from offshore market reduced,resulting in RMB settlement less popular and declined ratio among total imports.

2.1.2 Comparison of international trade settlement currencies

Under the current international currency system,USD,EUR and JPY are the currencies that rank top three and are also the main currencies that are used in the international trade settlement.As oil,gold and cereal are all valued and settled by USD,America processes the largest trade share around the globe.And therefore,as the dominant international reserve currency since the Bretton Woods system,USD has been undoubtedly the most important trade settlement currency internationally.Besides the European Union,the use ratio of USD in any country's trade makes over 50% and up.Till now,there are many developing countries whose over 90% trade settlements use USD.As to the European Union,the regional trades are quite developed that takes up to over 60% of the total trade amount.Generally speaking,the regional trades between countries are settled by EUR and the trades outside of European Union always used USD instead.As to Japan,the biggest creditor in the world,it makes JPY feasible to settle the export trades by providing loans to large sum of JPY to the Asia countries,ASEAN and many developing countries.In order to get JPY to pay their debts,many debtor countries are willing to accept the JPY settlement in the export trades.In Asia,the scale of trades used by JPY ranks only second to the one by USD and is much higher than the one by EUR.As currently there is no international organization to do the systematic statistics about the trade settlement currency,this report will use a research of the People's Bank of China (Table 2—1) to do a rough comparison of each nation's trade settlement currency situation.

Notes:1.Data in Germany refer to currency composition of the goods trade settlement while the others refer to the currency composition of goods and service.

2.The “Average” in the Euro zone refers to the mean of the settlement composition of the nine countries in the Euro zone,among which France adopts the 2003 year's data,Holland adopts the 2002 year's data and the other seven adopt the 2004 year's data.

Source:Goldberg and Tille(2005),Kamps(2006).

The proportion of America, European Union and Japan export used in domestic currency is higher than the one of import while the proportion of American and European Union export and import used in domestic currency is higher than that in Japan.This implies that the internationalized degrees of USD and EUR are higher than JPY.In 2004,settlement proportions in domestic currency in Euro zone of import and export were 50.7% and 56.7%.In 2003,settlement proportions of USD in America took up 85% and 95% of import and export.In the same year,the proportions of Japan using JPY among import and export are 24.6% and 38.4%.

In 2002,Britain's proportions to use domestic currency were 33% and 51% among imports and exports and its export settlement proportion by domestic currency approached to the EUR,which implied that GBP still was highly internationalized.The trade settlements in Asian countries such as South Korea,Malaysia,Indonesia and Thailand mainly used USD.For example,over 80% of import and export trades were settled in USD and proportions of using JPY and EUR were quite small.Trades inside ASEAN also used domestic currency to settle,for example,the ratio of domestic currency settlement was 5% among Thailand import and export trades.

Compared with the currency settlement degrees of America,Britain,Euro zone and Japan,China is still weak.Figure 2—5 illustrates the difference among trade settlement functions of different currencies.Although each country's index is in different years,which makes comparison not very accurate,the horizontal comparison still can reflect the degree of RMB's functions in trade settlement owing to the consistency of international trade settlement pattern.As is shown in Figure 2—5,the settlement ratio of China's export trade by domestic currency was 2.9% in 2011,8.7% of Britain's (lowest among the main countries) and only 3% of America's (highest among the main countries).China's domestic currency settlement among import trades was 10.9%,44% of Japan's (lowest among the main countries) and 12.8% of America's (highest among the main countries).

Figure 2—5 Ratios of domestic currency settlement in exports and imports

Note:Because of the accessibility of data,the year used is America (2003),Britain (2002),Japan (2003),Euro zone (2011),and China (2011).

Sources:The European data come from the European Central Bank's Euro's international role in July 2011 and the Chinese data come from the People's Bank of China,the other rest from Table 2—1.

To sum up,the cross—border RMB settlement is still in the early stage of development and its internationalized degree lags much behind the degrees of USD,EUR,JPY and GBP.In other words,once the import—export RMB settlement ratio is raised,RMB internationalization can be greatly promoted.