Will China Soon Have an International Currency?

Executive Summary

In the second of two reports on China’s desire to increase its heft in the international monetary system, we focus on the efforts of the Chinese government to internationalize the use of its currency. The Chinese government is relaxing the restrictions on foreign ownership of Chinese assets, and foreign holdings of yuan-denominated bank deposits, debt securities and equities have all increased significantly in recent years. However, foreign holdings of Chinese assets remain tiny when compared to the amount of U.S. assets held abroad. It likely will be years, if not decades, until foreign ownership of Chinese assets approaches the levels achieved by the greenback and the euro.

Is the Renminbi “Freely Usable?”

In our first report on China’s desire to increase its heft in the international monetary system, we discussed the country’s efforts to establish the Asian Infrastructure Investment Bank (AIIB), which some observers see as a potential competitor to the Asian Development Bank (ADB) and the World Bank, multilateral institutions that are dominated by the United States and other advanced economies.1 In this report, we focus on the efforts of the Chinese government to internationalize the use of the Chinese renminbi.

To the best of our knowledge, there is not a widely accepted definition of an “international currency” other than one that is “freely usable.” Although the U.S. dollar may not be widely accepted for payment for goods and services in most European countries, individuals in those countries would have little difficulty acquiring dollars if they chose to. In that sense, the U.S. dollar is freely usable. Other freely usable currencies that spring to mind are the euro, the Japanese yen, and the British pound. The U.S. dollar and these other three freely usable currencies are included in the Special Drawing Rights (SDR), an international reserve asset of the International Monetary Fund (IMF).3 Inclusion in the SDR would be a bona fide sign that a currency has approached, if not achieved, status as an international currency.

When the IMF last reviewed the composition of the SDR in 2010, it determined that the Chinese yuan should not be included in the basket because it was not a freely usable currency at that time. The IMF will review the composition of the SDR this year, and some observers believe that the IMF may decide to include the Chinese yuan in the SDR. Whether or not the yuan is freely usable at present is open to debate. As we detail in the remainder of this section, however, international use of the Chinese yuan clearly has increased over the past five years. One way to increase the international use of a currency is to encourage exporters and importers to demand that payments for international trade in goods and services be settled in that currency.

Starting in 2009, when the Chinese government first allowed international trade in goods and services to be settled in domestic currency, the use of the yuan as a settlement currency exploded. As shown in Figure 1, more than CNY 6 trillion (about $1 trillion) worth of trade in goods and services were settled in yuan last year. About 20 percent of Chinese trade in goods and services is now settled in yuan.

Foreign private holdings of Chinese currency and yuan-denominated deposits have also exploded over the past decade. Foreign private holdings of Chinese currency and yuan-denominated deposits totaled roughly $500 billion at the end of last year, up from less than $40 billion in 2004. In sum, the international use of the Chinese renminbi has increased significantly over the past few years, and it seems likely that the trends that are portrayed in Figures 1 & 2 will remain in place for the foreseeable future.

As more Chinese yuan make their way overseas, foreign central banks likely will increase their holdings of the Chinese currency in their foreign exchange (FX) reserves. Although data on the currency composition of individual central banks’ FX reserves are not available, aggregate data from the IMF show that “other” currencies (i.e., currencies other than the U.S. dollar, the euro, the Japanese yen, the British pound, and the Swiss franc) accounted for less than 2 percent of worldwide FX reserves in 2007.4 That share had grown to more than 6 percent by 2013. The Chinese yuan undoubtedly contributed to some of this rise in the use of “other” currencies as FX reserves by the world’s central banks. That said, the vast majority of FX reserves is held either in U.S. dollars (60 percent) or euros (25 percent). The Chinese yuan is just a bit player at present as a FX reserve currency.