Monday, December 22, 2014

RMB Internationalization and its Influences on Taiwan

Darson Chiu

       Tremendous attention has been paid to the fact that the Chinese Yuan (RMB) is the fastest growing currency in terms of for trade settlement. However, the RMB is still very unlikely to replace or challenge USD in this incumbent century. According to a recent report by the Bank for International Settlement (BIS), the USD is 40 times more used than RMB is for business transactions in the world. In that case, why has RMB internationalization become an issue since the recent two decades ago? Why such an issue is always extended to the RMB challenging USD scenario?

       As said by the SWIFT, an international provider of financial messaging agency, the RMB has become the world's 7th most used currency for payments in 2014. Those six other more used currencies would be US dollar (USD), euro, UK sterling, Japanese yen, Canadian dollar, and Australian dollar in rank. There's no surprise that the USD is still the most used currency with its distinguished status and unique advantage. As the biggest economy and largest market for end products in the world, the USD monopoly is expected to go on for years to come.

       In spite of that, the world is not happy with the US irresponsible fashion of leadership. The series of US quantitative easing measures launched during the ''made in US'' crisis and planned to end in October 2014 have long been criticized and described as beggar-thy-neighbor policies. On top of that, Darson Chiu such policies have been adopted by the US Federal Reserves to cope with negative impacts and consequences of the global financial crisis triggered by the US subprime housing bubble burst. Disappointed at the US economic performance, the world intentionally put China on the spot.

       China has been on the rise as a new economic giant in terms of aggregate GDP. It is therefore sensible that people have high hope for China's role on the stage of global economy and thus believe it is time for the RMB to be an international currency. However, currency liberalization is the sufficient condition for currency internationalization. As China is still having exceptionally rigid control over its capital account, RMB internationalization is a goal hard to fulfill in the near future.

       The well known Triffin dilemma concept argued that a nation whose currency being the international currency must be able to supply the currency to meet the global demand. That implies that such a country has to run a current account deficit. The US and its USD would be the case in point. China on the other hand has long been enjoying its trade surplus especially over developed economies like the US and Europe. Many must have some serious doubt that China is even willing to give up its surplus and internationalize RMB.

       Furthermore, using a currency is without a doubt a hard habit to break. As global trade has long been denominated by the USD, it will take a major and unanimous structural change for other currencies to replace RMB. In theory, an international currency must meet three criteria when it is used across borders: a) a medium of exchange, b) a unit of account, and c) a store of value. In other words, an international currency must be a currency for settlement, invoice and reserve all at once. Nevertheless, the RMB has been slowly but surely meeting those criteria, despite the fact many global traders are still used to USD.

       In addition, the mainland Chinese companies have been trading with neighboring economies, mostly Asian countries in RMB. Several central banks in the world including the Central Bank of Taiwan (CBC) have added RMB to their foreign exchange reserves portfolio and might gradually increase the RMB ratio in reserves with its propensity to appreciate in the future. In addition, world major central banks such as the Bank of England (BOE) and European Central Bank (ECB) signed bilateral currency swap agreements with the People's Bank of China (PBOC). So far, PBOC has signed swap agreements with around 40 central banks that could obviously enhance the global acceptance of RMB.

       The RMB internationalization is certainly not a goal to be fulfilled overnight, but it seems to be an inevitable trend at its own slow but sure pace. China has been Taiwan's number one exports destination accounts for 40% of Taiwan's total exports. Since2013, China has also become Taiwan's biggest imports origin accounting for 16-17% of Taiwan's annual imports. The CBC has expressed interest in signing a cross-strait currency swap agreement with PBOC. The Taiwanese government has also indirectly approached Beijing to expand the quotas for RMB Qualified Foreign Institutional Investors (RQFII) hoping to expand offshore RMB business. Some even suggested that Taiwan ought to cooperate with the Shanghai Free Trade Zone and acquire financial benefits as soon as possible.

       There are indeed certain advantages for Taiwanese businesses with respect to the RMB internationalization. The transactional costs should be further reduced as cross-strait trade could be settled in RMB. And there will be more opportunities for Taiwanese to work with Chinese businesses. On top of that, there is also a chance for Taiwan to develop into an offshore RMB financial center. However, Taiwan must be aware of the potential challenge and risk.

       China has tried to localize its supply value chains even before the global financial crisis. As a result, the status of cross-strait trade relations has turned from complementation to competition. The increasing rate of Taiwan's exports to China stood at 115% in 2002 and 118% in 2003 respectively. The rate dropped to 59% in 2004 and further declined to 20% in 2005. The period before financial crisis would be the first phase of China's supply chains localization. In the post crisis era, to deal with shrinking demands of world markets, China launched its second phase of localization policies. Said policies cause serious impacts on Taiwan's exports, as Taiwan's economy has been relying on exporting intermediate goods to China.

       Once China further makes progress towards its currency internationalization, their industries will become even more competitive. Chinese businesses can then save transactional costs by lowering foreignexchange risks, provide better offers and discounts when competing with Taiwanese businesses, and acquiring advanced technology with lesser costs etc. In the long run, the challenge for Taiwan will get tougher when dealing with RMB internationalization. It is therefore critical for Taiwan to seriously and carefully position itself for potential impacts in addition to merely gawking at benefits of future RMB status. How to effectively convert challenges into opportunities would be the key for Taiwan to prevail.

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