The article first appeared in the International Monetary Review, October 2022, Vol.9, No.4.

Herbert Poenisch, member of IMI International Committee, former senior economist, BIS.

Until the beginning of the Pandemic, goods, services as well as finance were moving mostly unimpeded round the world. Globalisation was ticking round like a Swiss clock. President Xi Jinping of China presented his country as the champion of globalization at Davos in early 2017. However, signs were appearing on the horizon that not all is well.

In geopolitics, the signs were set by Russia, China and the USA. In 2007 President Putin spoke out against the leadership of the USA and proposed a multipolar system. President Xi did not express it in such a clear way but it became increasingly clear after 2017, that China was aiming to become the world leader, casting aside the paradigm of Deng Xiaoping, ‘hiding your strength and biding your time’.

The Make America Great Again strategy of President Trump was a clear signal to the world that the US was moving away from unfettered globalization. The beginning of the war in Ukraine brought sanctions from the US and its allies which severely affected global trade and capital movements. In addition, covid19 necessitated lockdowns in China which severely affected supply chains which had already been strained during the pandemic.

This article will explore how the internationalization of renminbi will be affected by new geopolitical realities. After outlining the new paradigm in geopolitics, the recent development of RMB use in global finance according to the PBoC, IMI, SWIFT and BIS statistics and analysis will follow, and finally round off with the outlook for RMB use under these changed circumstances.

1. The new paradigm in geopolitics

The dominance of the US world order since WWII has brought peace and stability to the world. Isolated wars flared up but the basic order and institutions were never challenged, most importantly by the permanent members of the UN Security Council. They were grudgingly accepted. However this changed with Russia becoming more assertive during Putin’s second presidency. Equally, China under President Xi became increasingly assertive, particularly during his second period in office as from 2017. This not only affected the global political order but also economics and finance.

China’s steps towards establishing its own economic and financial order were boosted by its Belt and Road Initiative (BRI). By early 2022, some 164 countries had joined this plan amounting to close to USD 1tr. Under the BRI, China not only provided funds for infrastructure investment, thus bypassing the World Bank but also liquidity support, thus bypassing the IMF. The funds were provided by the Chinese policy banks and major commercial banks, each one of which has more financial assets than the established World Bank or IMF. China played its economic clout to underpin its global ambitions.

Russia’s global ambitions are far more modest and provide mainly military support for some countries. However, it set a new geopolitical paradigm by launching the invasion of Ukraine, thus furthering its imperial ambitions by breaking many international rules. Since the war Russia has demonstrated its part in a multipolar global system, which is not part of the Western global order.

The response of the USA and its allies was the imposition of broad sanctions which affected the global economic and financial functioning. The sanctions covered a wide array of financial transactions, starting with freezing the assets of the Bank of Russia, boycotting Russian banks to excluding Russian banks from SWIFT. This came on top of US led trade sanctions and technology protection against China.

2. Recent indicators of RMB Internationalisation

According to available statistics from the PBoC, IMI (see summary of RMB Internationalisation Report), the BIS 2022 foreign exchange triennial report and the monthly SWIFT RMB tracker, RMB use has increased steadily in 2020 and 2021, but not in leaps and bounds. However, these published indicators do not include bilateral settlement in RMB, mostly of goods and services thus potentially understating the comprehensive use of RMB.

One of the notable conclusion in the 2021 PBoC RMB Internationalisation report is that financial transactions up by 58.7% contributed mostly to the rising use of RMB in 2019 and 2020, while RMB use for current account transactions rose by only 12.1% yoy (figure 2-1).

Another pertinent conclusion was that in relations with Belt and Road countries settlement for goods and services in RMB increased by 18.8% yoy, whereas settlement of direct investment was RMB 434.12 billion yuan, a yoy increase of 72.0%. This would suggest a reversal from previous financing of Chinese BRI projects in USD.

Altogether, direct investments, portfolio investments and other cross-border financing accounted for 17.7%, 76.4% and 4.3% of the total settlement in RMB under the capital account respectively. It is noteworthy that 2020 still showed net portfolio inflows of RMB 578.39 billion yuan, contributing to the sharp rise in RMB use. This trend was reversed in the 1H2022, with consequences for RMB.

In 2020, the Cross-border Interbank Payment System (CIPS) operated steadily, handling a total of 2.21 million cross-border RMB transactions with an overall volume of RMB 45.27 trillion yuan, up 17.0% and 33.4% respectively yoy. In 2020, 9 new direct participants (4 of which were overseas RMB clearing banks) and 147 new indirect participants joined the CIPS. By the end of 2020, a total of 1,092 domestic and foreign institutions had linked to the CIPS through direct or indirect means.

In recent years, the RMB clearing business of overseas clearing banks has steadily increased, with an average RMB clearing amount of 344.76 trillion yuan and an average annual growth rate of 8.2% in the past three years. By the end of December 2020, altogether 907 participating banks and other institutions opened clearing accounts in overseas RMB clearing banks. In 2020, the RMB clearing amount of overseas RMB clearing banks totalled RMB 369.49 trillion yuan, increasing by 6.1% yoy.

The onshore RMB bond market has been attractive for foreign issuers (Panda bonds). By the end of 2020 the outstanding amounts have totalled USD 40bn. Main issuers are not only official borrowers such as IFC and ADB, governments such as of Hungary and the Philippines, but also private borrowers such UOB, BMW and Daimler and recently Rosneft.

In 2020, the offshore RMB deposits steadily increased. By the end of 2020, the RMB deposits in major offshore RMB markets exceeded 1.27 trillion yuan. The overall scale of offshore RMB loans remained generally stable, and the amount of outstanding RMB loans in major offshore markets was RMB 528.55 billion yuan. It can be assumed that the net RMB 500 billion was absorbed by issues in the offshore bond market, or flowed back into the onshore financial market.

Recently, the offshore RMB-denominated bond market has picked up after stagnating since 2015. Incomplete statistics showed that the total issuance of the RMB-denominated bonds in countries and regions, where overseas RMB clearing arrangements are established, amounted to RMB 331.96 billion yuan in 2020, with a yoy increase of 14.2%. The market is dominated by mainland issuers, such as the China Development Bank and other Chinese financials, but also Chinese property developers. They have been joined by foreign issuers such as McDonalds, Unilever and others, such as Australia National Bank and Maybank which raised funds for their China operations. Foreigners in total made up 20% in 2021.

The PBoC and BOC continued to intervene in the offshore RMB market. They are unlike the US authorities which never intervened in the offshore Eurodollar market. In 2020, the PBoC issued RMB-denominated central-bank bills in Hong Kong SAR of China markets regularly, further optimized the issuance structure of central-bank bills of different maturities, and improved the market activity of offshore RMB denominated central-bank bills. The PBC issued 12 batches of RMB-denominated central-bank bills including maturities of 3-month bills, 6-month bills and 1-year bills, with total amounts of 155.00 billion yuan in Hong Kong SAR of China.

On January 27, 2021, Bank of China (Hong Kong) launched the market-making mechanism for the repurchase of RMB-denominated central-bank bills in Hong Kong SAR of China, providing quotations for overnight, one-week, two-week, one-month, two-month and three-month repurchase and reverse repurchase of RMB-denominated central-bank bills.

In 2020, the RMB clearing amount of overseas RMB clearing banks had totalled in RMB 369.49 trillion yuan with a yoy increase of 6.1%, among which the clearing amount on behalf of clients and for the interbank had been RMB 37.63 trillion yuan and RMB 331.86 trillion yuan respectively, with each yoy increase respectively at 15.0% and 5.2%. By the end of 2020, 907 participating banks and other institutions had opened clearing accounts in overseas clearing banks.

The IMI RMB internationalisation index has fluctuated in the recent past. After reaching a high of 6 in early 2020 it declined to 4 during the course of the year, reaching 5.05 at the end of 2021. In early 2022 it receded again to 4.66. The RMB share in global trade (excluding finance) reached 2.85% at the end of 2021, whereas the RMB share of FDI, due to BRI investments reached 27.38%. The share of RMB in official forex reserves increased slightly from 2.8% at the end of 2021 to 2.88% in 1Q22.

The SWIFT RMB tracker reports that in July 2022, the RMB has retained its position as the fifth most active currency for global payments by value, including payments for goods and services as well as finance with a share of 2.20%, an increase compared with its share of 1.86% in July 2020. However, in the trade finance market, the RMB moved up to third position with a share of 3.07% in July 2022, compared to 1.84% in July 2020.

3. Outlook for global use of RMB in the new environment

All three functions of money, denomination and reference currency, transactions and store of value were fundamentally affected by the new geopolitical scenario. China has put in place the basic infrastructure for denominating commodities, such as oil and gold in RMB, clearing transactions in RMB though the CIPS payments system and offer onshore as well as offshore RMB as borrowing and investment currency.

Whereas during the USD era, major traded goods and services as well as invoices were denominated in USD, thus providing a reference currency, transactions mainly in USD through USD clearing system with notification through SWIFT messaging, and global lending and borrowing by non-US entities denominated mainly in USD. The major currency of issue of international equity and debt securities was also in USD. This process was helped by the deep and liquid Eurodollar market, which is a truly global financial market. Until very recently, both Chinese and Russian borrowers have benefitted from this global financial market.

The USD based global payments systems had two pillars, standard messages through SWIFT with membership of 200 countries and 11,000 participants, payments were cleared through the official FedWire with close to 10,000 participants or the private CHIPS with 47 member banks. Liquidity of USD payments is assured by the FED.

China operates its own global payments system, the official CIPS with 76 direct and 1228 indirect participants from 103 countries in early 2022. The system uses SWIFT messaging standards ISO 20022 but has to manage the risks of any payment system, such as credit risk and liquidity risk. The PBoC offers implicit RMB liquidity guaranty to the major Chinese banks.

CIPS is not China’s carbon copy of SWIFT as they have core technical and contextual differences. Technically, CIPS clears and settles RMB transactions, whereas SWIFT is a secured messaging protocol that lets banks “talk” to one another. Contextually, CIPS was created to improve the efficiency of RMB transactions, whereas SWIFT was created nearly 50 years ago by institutions from the U.S., the European Union and G-7 countries to enhance global financial messaging.

SWIFT and CIPS play different roles in international finance. SWIFT is a global secured messaging system that allows banks to communicate with each other with high efficiency and low costs. It does not move funds. Instead, it facilitates the secured flow of financial information across borders to support transactions. CIPS is different from SWIFT, as it is an RMB clearing and settling institution that utilizes SWIFT messaging to facilitate RMB transactions with the rest of the world. China’s CIPS is more similar to the United States’ CHIPS, which clears and settles domestic and cross-border U.S. dollar transactions and is plugged into SWIFT for cross-border messaging. Its volume is still a fraction of transactions settled in USD.

But the U.S. should keep a watchful eye on CIPS because it is a crucial piece of China’s broader ambition in international finance. China’s desire to lead in global finance is a stated goal, most recently enshrined in the Financial Standardization Five Year Plan (2021- 2025) released in February 2022. China can lay the groundwork for its ambition by strengthening the efficiency of CIPS, which could pave the way for RMB internationalization, but only if China first makes the whole suite of political and economic structural changes that would make the RMB a safer asset. International trust in the RMB as a safe asset and China as a reliable player in global finance is a necessary ingredient before CIPS can prop up China’s influence in the global financial ecosystem. Financial policymakers should study the growth in CIPS participation, as it is one indicator of RMB internationalization for China’s potential monetary ascendance.

Chinese policymakers have to contend with a policy paradox—China wants CIPS to be connected to the world yet also be a viable alternative to existing financial institutions. This is because CIPS needs SWIFT to operate in international finance. However, China simultaneously feels the powerful reach of American sanctions. Chinese academics have openly discussed that SWIFT is a point of contention between the United States and Russia. Russia has set up its own financial messaging system.

Moreover, China has been collaborating with other countries in providing alternatives to mainstream financial institutions. For example, China has a financial alliance with Russia. In 2010, the two countries agreed to use their currencies to settle bilateral trade instead of using the U.S. dollar. In 2014, the two opened their first currency swap line, which was renewed in 2017 and 2020 with the latest renewal entitling 150 billion yuan over three years. With a 35.9 percent increase in total bilateral trade in 2021, the continuing currency swap would be even more economically important to Russia (although most of China-Russia trade is still settled with the euro). Most recently, the Russian Mir card network was looking to further integrate with China’s UnionPay as Visa and Mastercard suspended their services to Russia. China has been replicating alternative financial arrangements across many other economies in the developing world. If more foreign banks join the CIPS (as either indirect or direct participants), that could be a sign that a China-led alternative channel could become stronger.

The introduction of the digital eCNY as a domestic currency will not boost the internationalisation of RMB. Only once the eCNY will be available for cross-border settlement, involved in multi CBDC projects, such as mBridge comprising eCNY, HKD, AED  and THB can the international use of RMB be boosted by digitalisation. There are many economic and technical obstacles on the way to a cross-border use of CBDC.

Regarding savings and investment, China has limited its residents from investing freely in global markets including the offshore RMB market. Rather than dismantling the remaining capital controls, these restrictions are here to stay and more strictly enforced. It remains to be seen how much Chinese entities will use the Southbound Bond Connect to have access to a greater pool of financial instruments available in Hong Kong SAR.

Foreign borrowers have been allowed to issue RMB debt securities in the onshore (Panda bonds) and offshore RMB markets (DimSum bonds). However, the volumes are still low, in the Panda bond market USD 40bn compared to total domestic bond issues of close to USD 12tr. The dimsum issues in Hong Kong amounted to RMB 110bn or USD 18bn in 2021.

Foreign investors from outside China and Russia are free to buy RMB securities issued in China, either as direct investors or though stock and bond connect schemes. This is part of the internationalization of RMB as are investments of foreign exchange reserves in RMB, such as by the Bank of Russia, which has substantially increased its holdings of RMB instruments.

Regarding raising funds, China has encouraged its residents to issue in offshore RMB markets, notably Hong Kong. Bond issues which were tightly controlled by Chinese authorities have been relaxed as have been issues of IPOs. Recently, the Hong Kong Mortgage Corporation and Cathay Pacific have joined other foreign corporations as issuers.

Chinese enterprises which had to delist in US equity markets due to accounting verification have issued IPOs in the offshore RMB market. It remains to be seen, how attractive these issues are for foreign investors, comparing the onshore and offshore returns as well as liquidity of investments in addition to assessing trust in RMB. It also remains to be seen, how access for various foreigners will converge. Will the Qualified Investor schemes such as QFII or QRII remain or will any foreign institutional investor be allowed equal access?

Conclusion

Policymakers would be remiss not to consider the alternative case, one in which China becomes a more prominent actor in global finance. Imagine a world where blocs have become more defined, where authoritarian countries have become accustomed to working with one another to mitigate the political and economic penalties from international condemnation. There might be just enough competitive pressure for China to make some painful structural changes to its political economic model, such as opening its capital account and embracing financial volatility. This might not happen for a while, but there might be an inflection point where the RMB becomes more attractive and is on the cusp of becoming a more influential currency. At that point, China will have had years to refine its financial plumbing, such as the Financial Standardisation Plan and cross-border eCNY mentioned above. CIPS and other financial mechanisms and digital innovations native to China could embolden China to contend with current mainstream financial mechanisms such as SWIFT. Then, China will be one step closer to meaningfully countering U.S. and allied sanctions. This is a big if, all contingent on whether China is willing to change its political economic model. Admittedly, China is highly unlikely to do just that in the foreseeable future, as long as the leadership’s calculus around social control and financial stability outweighs its ambition for a more internationalized RMB. However, U.S. policymakers should still keep a close eye on even a mildly successful expansion of the RMB. Because if the RMB becomes a more attractive asset, then CIPS, eCNY, Blockchain-based Services Network (BSN), and many other traditional and emerging financial mechanisms could get China to a position of strength to challenge leaders in the global financial order.

Literature used

BIS (2022): Triennial forex survey (forthcoming)

HKMA (2022): The 2021 Annual Report www.hkma.gov.hk

IMI (2022): Renminbi Guojihua Baogao 2022, July. www.imi.ruc.edu.cn

Jin, Emily (2022): Why China’s CIPS Matters (and Not for the Reasons You Think), In: Lawfare, 5 April www.lawfareblog.com

People’s Bank of China (2021): RMB Internationalisation Report, December www.pbc.gov.cn

People’s Bank of China (2022): Jinrong Biaozhunhua. 14th FYP Development Plan. www.pbc.gov.cn

SWIFT (2022): RMB Tracker Monthly reporting and statistics on renminbi (RMB) progress towards becoming an international currency, August www.swift.com