E Zhihuan: The Resumption of High Quality RMB Internationalization and the Financial Risk Control

2018-03-27 IMI

E Zhihuan, Member of IMI Academic Committee, Chief Economist, Bank of China (Hong Kong) At the beginning of 2018, spillover effects of monetary policies from major economies triggered simultaneous fluctuations in global financial markets. Persistent systemic risks revealed the intrinsic drawbacks under the existing global monetary system led by the US dollar. Diversification of global monetary system should proceed at a faster pace. Meanwhile, RMB internationalization has entered a new stage of development. In January 2018, the People’s Bank of China (PBOC) improved and optimized policies for cross-border RMB business. The policies sent out positive signals, which would support cross-border RMB settlement by enterprises, facilitate foreign institutional investors to use the RMB for direct investment, and promote RMB business for individuals. Control measures on cross-border fund flows, especially some temporary administrative measures, are likely to ease gradually given receding depreciation pressure on the RMB. This will provide favorable conditions for the resumption of RMB internationalization. Financial risk control determines the potential of RMB internationalization With deepening integration with the global financial system, China’s financial markets will engage complex global market environment directly and be subject to a variety of external shocks. As a result, risk control plays a crucial role in financial market opening. While external risks escalate, financial risks in China’s economic development are becoming more prominent. Total debt to GDP ratio climbed to 284% in 2017 from 277% in 2016. It requires tremendous efforts to reduce leverage ratio, while risks of shadow banking, property finance and internet finance continue to accumulate. Against the backdrop, there is urgent need to prevent and resolve financial risks through controlling leverage ratio, enhancing the adaptability of financial structure, increasing the capability of financial services to support the real economy, strengthening the development of mandatory constraint system and controlling systemic risks. The PBOC improved macro-prudential policies on cross-border fund flows and conducted counter-cyclical adjustments on capital flows. Moreover, the PBOC continued to deepen reform of the RMB fixing mechanism, based on market supply and demand dynamics and a basket of currencies, as well as adopting a managed floating exchange rate regime. Consequently, the RMB would be more determined by market factors with flexibility and maintain its stable status in the global monetary system. Apparently, China’s capability of controlling external and internal financial risks determines the potential of RMB internationalization. During the second half of 2017, market sentiment turned neutral with the RMB approaching equilibrium, and the central bank adjustedits policy timely by relaxing a series of "temporary" and "transitional"cross-border macro prudential management measures, including removing the risk reserve ratio of foreign exchange and the requirement for foreign banks to set aside reserves for offshore RMB deposits in China. In 2018, the expectation of RMB depreciation has reversed. The PBOC adjusted the counter-cyclical coefficient incorporated in central parity fixing model accordingly. The RMB fixing mechanism would be more liberalized, with more weighting on market supply and demand dynamics. Theoretically, this would be favorable for promoting businesses related to RMB internationalization. If systemic shocks occur in global financial markets, the stability of the RMB will be under new pressure, and the pace of RMB internationalization will be adjusted accordingly. Four takeaways on the roadmap of RMB internationalization First of all, RMB internationalization is a long-term strategy. Theory innovation and exploring the way of implementation are necessary regarding major topics on developing a modern economy. A theoretical framework should be built underpinned by macroeconomics and finance perspectives with a comprehensive and open approach. The basic roadmap of RMB internationalization is to persist in liberalization reform in foreign exchange market, maintain the RMB’s stable status in the global monetary system, resolve the systematic drawbacks under existing global monetary system led by the US dollar, provide an alternative option and new public goods from emerging markets, and offer a Chinese solution in order to promote a more robust and fair global monetary system. Next, create room for RMB internationalization, following the trend of China’s financial market opening, driven by policy while guided by markets. Technically, increasing the RMB’s proportion in global exchange reserves and foreign exchange market cannot be realized in a short period of time. Instead, it is necessary to explore from multiple perspectives, such as cross-border trade and investment, encouraging third-party usage, etc. Consequently, the collaborating development of merchandise trade, investments and financial transactions will help formulate an effective roadmap for RMB internationalization. In addition, demand for global asset management by domestic entities is likely to rise for an extended period of time. In China, the holding of foreign financial assets by private sector amounts to 27% of GDP. The ratio is significantly lower than 129% for the US and 147% for Japan. Therefore, the scale and structure of capital flows will continue to adjust and optimize, and the factors affecting RMB internationalization will be more diverse. A bottom line mindset with core value of controlling financial risks is needed. In-depth analysis on relevant policies and potential market impacts should be taken when making major policies. Finally, RMB internationalization is a major topic of global monetary system. The objective of RMB internationalization implies that China will take more responsibility on maintaining the stability of global financial system and play a proactive role in global financial governance. Accordingly, policy collaboration between domestic and foreign markets, taking into account the interests of domestic and foreign entities, should be emphasized in order to promote RMB internationalization progressively.

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E Zhihuan: The Resumption of High Quality RMB Internationalization and the Financial Risk Control

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