Regionalization of the RMB and China s Capital Account Liberalization

Transcription

1 86 China & World Economy / , Vol. 12, No. 2, 2004 Regionalization of the RMB and China s Capital Account Liberalization Jing Li* Abstract This paper investigates the current situation and main reasons for the massive circulation of China s national currency, the renminbi (RMB), in China s neighboring economies. It indicates that the expansive use of RMB in Asia is the beginning of the process of RMB internationalization. This process is being driven by a strong Chinese economy and increased investors confidence in RMB. Internationalization of RMB is a high priority for the Chinese government and the management of this process should depend upon a cost and benefit analysis of the various options available. At present, due to the developing nature of the Chinese economy, the internationalization of RMB is restricted to the Southeast Asia. Even so, this regionalization will impact China s current capital control regime directly. In order to eliminate the financial risks involved, transition measures should be prudently implemented. To be most effective the government should coordinate the processes of regionalization and convertibility of RMB. I. Introduction Since the late 1990s and especially after the Asian financial crisis of 1997, China s neighboring economies have gradually endorsed the renminbi (RMB) as a medium of exchange for international payments. Thus, a sizeable amount of RMB is circulating outside the Chinese mainland. This phenomenon of RMB internationalization, perhaps better described as RMB regionalization, has attracted great attention from policymakers and academics both at home and abroad. Given China s increasing economic importance, many scholars suggest that the Chinese *Jing Li, PhD in economics, Department of Economics, Capital University of Economics and Business, visiting fellow at Queen Mary, University of London. Lena98@sohu.com. The author thanks Elise McAuley, Renee Snijders, Nicholas Murray and Helen Oates for their comments and help.

2 Regionalization of the RMB and China s Capital Account Liberalization 87 government should take active measures to make RMB a future international currency. For example, Zhao Haikuan (2002) argues that with soaring economic growth and WTO accession, China s economy is becoming increasingly globalized. As a result, RMB will naturally become more widely used for international payments, and fulfill at least part of the function of an international currency. The Chinese government should have a positive attitude and take active measures to hasten this process. Zhong Wei (2002) puts forward instructive suggestions for the government concerning the path towards RMB internationalization and highlights possible problems along the way. He says that China should coordinate this process with the liberalization of the capital account. Wu Nianlu and Chen Quangeng (2002) illustrate the differences between currency convertibility and currency internationalization, as well as the benefits and risks of currency internationalization. They suggest that in order to create the right conditions for the internationalization of RMB, research into the gradual liberalization of the capital account should be done in the context of the international monetary system reform. The prospect of internationalization of RMB has also received attention in the international community. In 1999, the late renowned economist Dornbush argued in an article published in the German newspaper Der Spiegel that in 20 years, time there would be only a few world currencies. He predicted that the US dollar would dominate in North and South America, RMB would dominate in Asia and the euro would be the major currency in the rest of the world. 1 While many scholars are optimistic about the internationalization of RMB, some scholars, such as Jing Xuecheng (2000), have pointed out that RMB internationalization is a long-term process. Wang Jian (2002) predicts that a crisis is brewing in the international financial markets and consequently China should absolutely refrain from opening its capital markets and internationalizing its currency. He argues that China should maintain a closed capital account as it did in 1997 in order to escape the repercussions of a future crisis. Other scholars hold the opinion that because the Chinese market is insufficiently regulated and lacks a global financial center, the process of internationalization should be indefinitely postponed. It is apparent from the above introduction that a systematic analysis of the internationalization of RMB is yet to be undertaken. No consensus has yet been reached on the nature of the internationalization process and its probable impacts on the Chinese economy. At present, the internationalization is restricted to the Southeast Asian region. Expansion of RMB circulation beyond China s immediate neighbors will challenge China s capital control regime. The lack of theoretical and empirical work on the topic restricts the government s ability to take action. This paper concentrates on the nature of RMB 1 Quoted from Renminbi will possibly become international currency in the future Huasheng Bao, October 9, 2000.

3 88 Jing Li / , Vol. 12, No. 2, 2004 regionalization and its impacts on China s macro-economy. It also puts forward a proposal to coordinate the process of RMB regionalization with capital account liberalization. II. The Current Situation of RMB Regionalization The off-shore use of RMB takes on certain distinctive forms in the region: first, a medium of exchange in border trade and tourism; second, pure investment in Hong Kong SAR, Macao SAR and Singapore, where the circulation of RMB is not correlated with bilateral trade; and third, the provision of RMB deposits and services thus allowing the RMB to function as a second US dollar. The off-shore circulation of RMB has different channels and incentives. 1. The main channels for the outflow and inflow of RMB The increasing outflow and inflow of RMB is the result of a number of ongoing developments, such as the increasing economic and cultural transactions between China and its neighbors, as well as the Chinese government s corresponding deregulation of foreign exchange. 2 The main channels of RMB cross-border movement can be summarized as follows. (1) Tourist and family visits from the mainland With the return of Hong Kong to China and the sustained economic growth of the mainland, the number of tourists from the mainland to Hong Kong has soared. According to the statistics of the Hong Kong Tourist Board arrivals from the mainland experienced a spectacular increase of 52.1 percent over 2001, totaling 6.07 million in the first 11 months of The implementation of CEPA (Closer Economic Partnership Arrangement) and FITs (Free and Independent Travelers) will greatly enhance the economic links between mainland and Hong Kong, making Hong Kong an even more attractive place for mainlanders to invest and visit. The number of mainland tourists in Hong Kong is forecast to rise by 46 per cent year-on-year to at least 12 million in 2004, and they are expected to spend HK$59 billion in Hong Kong in 2004, contributing nearly 2 per cent of the GDP of Hong Kong. 3 The 2 In 1993, the State Council issued Regulations on Administration of Carrying National Currency of the People s Republic of China across the Border, stipulating that the entry and exit of the currency will be administered via quota by the government. The People s Bank of China determines the specified quota. In February 1993, the People s Bank of China issued The Bulletin of Quotas on Entry and Exit of Domestic Currency, which states that Chinese residents and foreigners can bring RMB 6,000 per person per entry. For boundary market or small-scale trade, the local branches of the People s Bank of China and Customs can work together to determine the quota. However, a quota can be implemented only after the People s Bank of China and General Administration of Customs approve it. In practice RMB 6,000 is the universal standard.

4 Regionalization of the RMB and China s Capital Account Liberalization 89 result will be a very large flow of RMB into Hong Kong. (2) The use of RMB in border trade In recent years, with the development of economic and trade communications between China and its neighboring economies, Chinese imports from Malaysia, Thailand, and Chinese Taipei etc. have increased very fast. For example, in 2002, the total amount of RMB in circulation stemming from Chinese border trade was estimated at RMB 23.7 billion, and the trade deficit up to RMB 8.4 billion 4. (4) Capital outflow resulting from FDI Chinese project-development contracts and Chinese central bank loans are two main channels of outflows of RMB. Economic and trade cooperation between China and its neighbors are still at an elementary stage of barter trade and the size of capital movement is relatively small. The Chinese government remains the key player in this category of capital outflow. (5) The RMB foreign exchange and NDF The RMB Foreign Exchange Centers in China s neighboring economies, and since 1996, Hong Kong s NDF (Non-Delivery Forwards) system, constitute two main channels for RMB off-shore circulation. At the same time, the black market is also an important channel for outflows of RMB. Since RMB is not a fully convertible currency, it usually cannot be circulated and deposited in the banking systems of neighboring economies. Consequently, movement of RMB takes the form of cash, and it is not used as a store of value. 2. The main reasons for off-shore circulation of RMB As the legal tender of China, the off-shore circulation of RMB is actually illegal. However, the expansion of the circulation of RMB outside China is the result of increased demand for RMB and is driven by the real economy (i.e. not governments). Two main reasons account for the present off- shore circulation of RMB. (1) The trade ties between China and its neighboring economies China s increasing economic and trade contact with the outside world is creating a huge demand for RMB. This has particularly been the case since the implementation of the Ninth Five-Year Plan ( ). See figure 1 and figure 2. A large proportion of Chinese trade with its neighbors, especially Chinese imports, is 3 Li Wenfang, Mainlanders cash to bolster Hong Kong s GDP by 2% survey. ± Chinadaily.com.cn. Dec.16, See The CEIC Asia Economic Database, mareodata.php.

5 90 Jing Li / , Vol. 12, No. 2, 2004 Figure 1. Total Value of Trade Between The Chinese Mainland and Economies Including ASEAN, Hong Kong, Taiwan And Russia Combined ( ) Unit: US$100 million Sources: China Foreign Trade Statistics During the Ninth Five-Year Plan Period, 2002, pp.18-20; The Statistics of Trade Between China and ASEAN Member Countries, 2002, pp. 8-15; The Dynamic Indicators of Foreign Trade December 2002, pp Note: The above three sources are edited by the Ministry of Foreign Trade and Economic Cooperation, People s Republic of China, unpublished Chinese government sources. Figure 2. The Ratio of Chinese Trade with Economies Including ASEAN, Taiwan, South Korea And Russia to Total Chinese Trade Sources: The same as Figure 1. settled in RMB. Trade therefore accounts for a significant outflow of RMB. As China continues to run a trade deficit with its neighbors, the increase in trade volumes will result in more and more RMB outflows to these regions. In this way, RMB will become more easily obtainable outside China and will become more easily accepted by non- Chinese residents.

6 Regionalization of the RMB and China s Capital Account Liberalization 91 (2) China s sustained economic growth and stable exchange rate China s sustained economic growth and stable exchange rate has enhanced the confidence of residents in neighboring economies in RMB. China s reform and opening of its economy, especially its sustained rapid growth, has enhanced its political and economic status in the world. The stability of RMB during the Asian financial crisis of 1997, despite the fall in value of other Asian currencies, increased people s confidence in both China s currency and economy. On the whole, the internationalization of RMB is a spontaneous process driven by the real economy and not the result of government encouragement. The internationalization of RMB sets a precedent for developing countries and demonstrates two striking characteristics. 3. The Characteristics of RMB Regionalization The characteristics of RMB regionalization are striking, and may influence the path of its further internationalization progress. (1) The asymmetry of RMB regionalization with convertibility of RMB Generally speaking the internationalization of a currency only takes place after full convertibility (i.e. current and capital account convertibility) has been achieved. While in China current account convertibility has been realized, restrictions remain on the capital account. These restrictions were even enhanced for a period of time after the Asian financial crisis, somewhat paradoxically coinciding with an increase in the circulation of RMB in the region at that time. This poses a problem for China s current capital control regime that the authorities cannot afford to overlook. How to reconcile the regionalization of RMB with liberalization of the capital account, in order to guarantee a smooth and stable move towards internationalization of the currency, is a formidable task facing China s macro-economy today. (2) Asymmetry of RMB regionalization with China s overall economic development In general the internationalization of a country s currency happens at an advanced stage of its economic development. In the case of China, it is related to its high rate of economic growth, and hence continued faith in RMB relies on China s continuing achievement of 7-8 percent growth. The present internationalization of China s economy is not matched by its state of economic development, so it could possibly be a long time before RMB circulates widely beyond Asia. Therefore in addressing the challenge of the regionalization of the currency, policy makers must be aware of the advantages and disadvantages inherent to this process.

7 92 Jing Li / , Vol. 12, No. 2, 2004 III. The Benefits and Costs of RMB Regionalization The analysis of the costs and benefits of RMB regionalization will determine how positively the government will react to regionalization of the currency and what policy choices they will make. 1. The benefits (1) Potential seigniorage The greatest benefit accruing from internationalization of the currency is the potential income from seigniorage. Regionalization of RMB is actually the exchange of paper money for real resources. Not only may this open a new channel for the flow of funds for China, but it will also improve China s status and influence in international affairs, especially in Southeast Asia. The seigniorage revenue resulting from the outflow of RMB can be both calculated and predicted. (2) Enhancing regional economic cooperation Regionalization of RMB will benefit economic cooperation in Southeast Asia. It will reduce transaction costs and exchange rate risks, thereby increasing the profitability of the ASEAN free trade area and quickening economic integration pace. The regionalization of RMB is a spontaneous process that is not the result of systematic and coordinated cooperation. It will give a firm basis for further progress in cooperation, reduce the cost of regional harmonization and increase the speed of integration. Moreover it will bring into full play China s role in the process of economic cooperation in Southeast Asia. Extensive circulation of RMB in Hong Kong, Macao and Taiwan specifically will increase trade within the Greater China and bring the same benefits of integration as mentioned above. 2. The costs However, as with any process of currency integration, regionalization of RMB also means certain risks. (1) The traditional Triffin Dilemma As with any other currency, regionalization of RMB will create problems with providing sufficient international liquidity while maintaining exchange rate stability. China must provide sufficient outflows of RMB in order to maintain liquidity in Southeast Asia. For the most part the outflow of RMB at present is the consequence of China s trade deficit with Indonesia, Malaysia, Thailand, Mongolia and China s Taiwan. However, if the RMB is to become a regional currency, maintaining price stability and balance of payments will be quite important for ensuring its good reputation. Therefore when China experiences a trade deficit, the deficit has to be covered by a capital account

8 Regionalization of the RMB and China s Capital Account Liberalization 93 surplus so that the equilibrium of balance of payments can be maintained, the external value of RMB remains stable and the status of RMB as an international currency can be consolidated. (2) The effectiveness of monetary policy could be influenced The formulation and implementation of monetary policy will be subject to sudden currency inflows and changes in money demand. This will challenge the independence of China s monetary policy 5. As an international currency, international capital flows will influence the interest rate, exchange rates and price levels. This therefore requires the Chinese monetary policy authority to strengthen its macro- economic management ability and make the microeconomy more flexible. (3) RMB will, after its regionalization, assume responsibility for regional financial stability For the foreseeable future, the internationalization of RMB is mainly restricted to Southeast Asia and therefore the most important externalities of China s macro economic policy decisions will be in Asia. This makes harmonization with the macro- economic policies of other countries in the region a necessity. In the event that speculation in the region threatens to undermine economic stability, China must assume the role appropriate for a country of great size and act as a lender of last resort. (4) Regionalization of RMB could precipitate a revival of anti-china cliché In the context of the slowdown of the world economy, China s rapid economic growth is regarded as exceptional. The large amount of foreign trade and investment that China attracts has caught the attention of other countries. Undeservedly, some countries suggest that China is exporting deflation to Asia and maybe even to the world. Talk of the regionalization of RMB may encourage propagation of anti- China cliché (Haruhiko Kuroda, 2002). International society has put pressure on China s exchange policy. 6 This pressure may influence the overall design and sequence of China s reform and opening up. Overall, increased circulation of RMB in China s neighboring region accords 5 Independence of monetary policy means that the monetary authority is able to determine the desirable money supply and interest rate level according to the requirements of the macro- economy. 6 The United States, Japan and South Korea have called on China to let the RMB appreciate. They complain that RMB is undervalued and is increasingly making China s exports cheaper. US manufacturers complain that China has kept its exports artificially cheap by keeping RMB undervalued against the dollar, resulting in losses of US manufacturing jobs. In the U.S. Congress, lawmakers pushed for legislation that would impose import tariffs on Chinese products comparable to the amount they claim China s currency is undervalued.

9 94 Jing Li / , Vol. 12, No. 2, 2004 with the needs of China s present economic strategy and is beneficial for the implementation of China s Greater Economy and Trade strategy 7. Regionalization of RMB should not conflict with the requirements of China s financial stability and successful implementation of its monetary policy regime. China can take appropriate measures in order to further stabilize and smoothen the process. Specifically, due to the close relationship between RMB regionalization and convertibility, China must harmonize these two developments in such a way as to reduce the financial risks that may involve. IV. The Impact of RMB Regionalization on China s Current Capital Control Regime To some extent, the regionalization of RMB and liberalization of the capital account is asymmetric. Generally speaking, the internationalization of a currency should happen after full convertibility (current and capital account convertibility). However, at present restrictions remain on China s capital account, and were even enhanced after the Asian financial crisis. 1. Conflict between the de facto convertibility of RMB in China s neighboring economies and the de jure authorization of the Chinese capital control regime Increased off-shore circulation of RMB is a spontaneous and market-driven process, and presently not subject to government control. However, the Chinese government is facing up to the reality of de facto convertibility of its currency. The government can choose between a number of strategies: it could address this issue unilaterally, negotiate for a bilateral agreement, or allow the invisible hand of the market to automatically determine the off-shore use and circulation of RMB. In any case, coordinating the process of RMB regionalization and liberalization of the capital account, while assuring the stability of the process, is an unprecedented challenge for the Chinese authorities. 2. Potential problems for the foreign exchange supervisory body resulting from increased circulation of RMB The growing multiplicity of channels for the outflow of RMB potentially increases the 7 China s Greater Economy and Trade is alternatively defined. Here it refers to economic integration of the Mainland, Hong Kong, Macao,Taiwan, and the other overseas Chinese economies in Asia.

10 Regionalization of the RMB and China s Capital Account Liberalization 95 range and scope of RMB-denominated transactions taking place outside the Chinese legal system, and is therefore a source of great concern for the Chinese financial and foreign exchange supervisory body. For example, the investment of mainland capital in the Hong Kong market is in principle subject to strict regulation, however off-shore RMB circulation and de facto convertibility weaken the effectiveness of these regulations, and consequently the control of the Chinese authorities. 3. Increasing demand for fostering the outflow and return mechanism for the regionalized RMB Non- residents regard RMB not only as a medium of exchange and payment, but also as a type of (value-retaining) asset. As the issuing country, it is important that China ensures the stability and increasing value of this asset, because this would stabilize the off-shore demand for RMB, and in the context of a non-convertible RMB, is also very important for guaranteeing the financial stability of China. Consequently, the Chinese authorities must facilitate stable returns for off-shore holders of RMB, by allowing the return of RMB to the mainland particularly in the form of investment. The Chinese capital management system could be reformed to allow the return of RMB to China by loosening the restrictions on foreigners holding financial assets such as stocks and bonds. This is an important aspect of the policy to encourage foreign investment. 4. Does the move towards regionalization of RMB threaten to open the floodgates? As the legal tender of China, off-shore circulation of RMB is technically illegal, and part of the outflow of RMB takes place via the black market. This could constitute a hole in the financial dam. Because no management system can be water- tight, there will always be some opportunity for capital flight. The experience of the 1998 balance of trade deficit drove home to the Chinese policy-making and academic community an important lesson. 8 Even while the regulatory system is imperfect and the financial market is incomplete, it is still important to work on improving the administration of the capital account, and at the same time harmonize and coordinate this with other policies. The increasing internationalization of RMB would validate and facilitate China s 8 In 1998, while China s Balance of Payments had US$23 billion surplus, the foreign exchange reserves increased by only US$5 billion. The rest of surplus has gone. The scale of capital flights in the 1990s was large, and it has been reduced only since the late 1990s.

11 96 Jing Li / , Vol. 12, No. 2, 2004 emergence as a global economic power and reduce its dependence on the US dollar, and it would also make RMB financing possible throughout the region. It must be noted, however, that for RMB to emerge as the dominant Asian currency, it will take time, and the Chinese government must take a supportive but cautious approach for RMB internationalization. V. The arrangements for the transition to RMB regionalization The regionalization of RMB and its eventual internationalization, must be steady and gradual, accommodating the overall framework of China s reform. Given China s present economic situation and the global economic environment that China faces, the process of regionalization of RMB and the liberalization of the capital account must be combined in order to reduce the risk involved. It is becoming a mounting issue for Chinese government to take effective measures to guide and regulate the RMB in circulation outside China, and in particular should consider the four main areas that follow. 1. Adjustment of the capital control system Two prerequisites for the holding of RMB by China s neighbors are stable exchange rate and wide- range acceptability. To first encourage the regionalization of the currency and maintain an unhindered flow of RMB, the government must create effective channels for the circulation of RMB throughout the region. (1) Creating effective channels for a reasonable outflow of RMB If a country s national currency is to become an international one, that county must first export its money. There are two possible strategies for the Chinese authorities to achieve this. One is through trade deficit with Southeast Asia and another via capital outflow to Southeast Asia. For China, the border trade will play a major role in pushing the internationalization of RMB. In the near future, the border trade deficit will become the main channel of RMB outflow in neighboring economies. In October 2003, Chinese government carried out a new policy permitting the use of RMB as a settlement currency for border trade, it is a great breakthrough in the process of RMB regionalization. China should make full use of increasing trade opportunities with neighboring economies after its entrance into the WTO. China should for example consciously encourage the use of RMB for settling payments in the trade. The currency account settlement and conversion facilities required for bilateral trade relations (including intangible trade) should be placed squarely in the financial service system. In order to secure bilateral trade settlements, China should gradually seek to sign

12 Regionalization of the RMB and China s Capital Account Liberalization 97 account settlement and payment agreements with its most important trade partners. Outbound FDI (foreign direct investment) by Chinese investors may also be an important way to promote RMB regionalization. The Chinese government should encourage Chinese companies to be more outward focused and explore the possibility of green-field investments 9 in Southeast Asia by permitting the use of RMB for outbound FDI. In conjunction with the notable rise of Chinese industry, Chinese companies investment in Southeast Asia actually increases year on year, but there is still room for Chinese companies to increase investment and cooperation within ASEAN. In order to encourage this the Chinese government will need to offer convenient credit facilities for investment of RMB abroad and allow the use of RMB for financing projects. Furthermore the system of authorization could be adjusted to allow relatively small-scale FDI projects to go ahead with simplified procedures. Bilateral negotiations between Chinese government and some neighboring economies could also make it easier for Chinese companies to invest outside China. (2)Creating the channels for return of RMB outflows to the mainland Stable and effective channels for the return of RMB to the mainland are crucial for the effective off-shore circulation of RMB. Following the increased scale of RMB circulation, the function of RMB has developed from a mere means of transaction to a type of asset that stores wealth. It is therefore important for the holders of RMB that the value of this asset is maintained and increased, most particularly in those economies where RMB is officially convertible and is a significant savings asset 10. The government should work to develop channels for the return of RMB to the mainland, which are necessary to reduce the insecurity felt by these foreign RMB holders. Due to the incomplete development of the domestic capital markets and frequent fluctuations in value of the stock market, these Chinese markets cannot be considered an ideal investment environment for foreigners. But China s bond market can satisfy the demands of foreign investors and could in principle facilitate a stable inflow of investment, functioning as an asset pool. We should look to the bond market therefore to provide a stable channel for the return of RMB outflows, thereby avoiding the financial risks involved in large-scale and unexpected inflow of the currency. The realization of this strategy will not only ensure the smooth bilateral circulation of RMB, but also help to more accurately keep track of the demand and supply of RMB, thus enhancing the ability 9 Green field investments refer to investments to build new factories and power plants. 10 In Vietnam, Burma, Laos, North Korea, Mongolia, Russia, Pakistan and Nepal, RMB is widely accepted as a settlement currency; In Hong Kong SAR, Macao SAR, Bangladesh, Malaysia, Indonesia, Singapore, the Philippines and Korea, RMB deposits are conducted; In Malaysia and Korea, RMB has become part of foreign reserves.

13 98 Jing Li / , Vol. 12, No. 2, 2004 of the government to implement prudent monetary policy. In addition, China could consider signing central bank agreements with other economies. They could agree that a portion of RMB can be converted into a currency that is more widely convertible, or they could agree that a portion of RMB be made available to be used by foreigners for FDI in China. Since ASEAN is the most important region for China to attract FDI, regarding off-shore RMB as foreign capital could help to increase investment in China by other ASEAN member countries. 2. Hong Kong s influence on the regionalization of RMB Hong Kong has a natural economic relationship with China and is already a significant financial center in Southeast Asia. China could use Hong Kong as a testing ground, fostering the development of Hong Kong as a RMB off-shore financial center. Since 1993 RMB has been widely accepted and used in Hong Kong. As far as Hong Kong residents are concerned, holding RMB is a matter of convenience and moreover of necessity. In 2002, Hong Kong banks presented a proposal to accept RMB savings, which would pave the way for Hong Kong to become off-shore RMB center, making Hong Kong an even more important financial center. On 19 November 2003 the People s Bank of China and the HK monetary authority signed a cooperation memo for conducting RMB business in Hong Kong. With the approval of the State Council, the People s Bank of China will provide clearing arrangements for banks in Hong Kong to conduct personal RMB business on a trial basis. Starting from 2004, Hong Kong banks can conduct RMB transactions that facilitate personal spending, which include savings deposits, currency exchange, remittances and RMB cards. As for RMB cards, Chinese mainland residents may use RMB debit cards and credit cards issued by mainland banks for spending in Hong Kong. Participating banks or their subsidiaries may also issue RMB debit cards and credit cards to residents of Hong Kong for use in the Chinese mainland. The experience of managing RMB business will prepare Hong Kong for its future role as an off-shore RMB business center. The degree of capital restriction in Hong Kong and China is at present not the same, and therefore for Hong Kong to develop a RMB savings business, China s capital controls must first be relaxed. The freedom of convertibility of the Hong Kong dollar and the lack of capital controls mean that if Hong Kong were to become an off-shore center for RMB, it would have a fundamental impact on the capital control system of China. The complications involved in the relaxation of China s capital controls in order to facilitate this new function for Hong Kong must not be underestimated. This relaxation, including the relaxation of the administration of capital flows between Hong Kong and China, should not be allowed to endanger the policy goal of currency and financial stability. Any progress towards the realization of Hong Kong as an off-shore RMB financial center will require a well- prepared monetary and financial

14 Regionalization of the RMB and China s Capital Account Liberalization 99 system so that China can attract foreign capital in an effective and timely way. 3. Stimulating Asian economic cooperation The regional circulation of RMB will inevitably be negatively impacted by some unforeseeable factors, for example, another financial crisis in Asia in the future cannot be ruled out. In order to avoid another tragic scene of financial crisis, the economies of Asia must quicken the pace and enrich the content of cooperation. At the time of the previous crisis China undertook a large degree of responsibility and its China will not devalue policy became a bulwark for the Asian regional economy. China has persistently pushed for Asian financial and monetary cooperation, and has had great success. China took the initiative in the establishment of ASEAN + 3, the signing of the Chiang- mai Initiative as well as fulfillment of bilateral currency swap agreements. China wants to play a major role in promoting the future cooperation of Asian economies, including enlarging the scope of currency swap agreements, enhancing cooperation in economic and other areas and consolidating the already-established channels of cooperation. In order to protect the stability and safety of the regional circulation of RMB, China must build on bilateral and common interests to strengthen central bank cooperation between each economy. For example, in order to stabilize exchange rates, China must promote exchange rate system cooperation and harmonization; and in order to prevent irregular capital flows, it must strengthen transnational monitoring and control of capital flows. 4. Improving coordination with other macroeconomic policies Circulation of RMB outside China will have direct effect of loosening capital controls and will make it more difficult for the government to practice independent monetary policy. Consequently the regionalization of RMB and pursuit of convertibility agreements must be coordinated with other macroeconomic policies. A stable exchange rate is a pre-condition for guaranteeing stable off-shore circulation of RMB. Therefore in order to stabilize the exchange rate, China s economic growth and its balance of payments must be maintained and the vibrancy of the outward-oriented economy must be stabilized. Coordination of macroeconomic policies is vital for the success of this systematic process. VI. Conclusion Due to the rapid pace of China s economic growth, the stability of the exchange rate, and the high level of responsibility borne by the Chinese government at the time of the Asian financial crisis, the demand for RMB has been continuously on the increase. RMB has

15 100 Jing Li / , Vol. 12, No. 2, 2004 become an important means of circulation, payment and saving in neighboring economies. While the internationalization of RMB is certainly on the agenda, for the time being circulation of RMB will be restricted to the Asian region. Regionalization of RMB is an important manifestation of China s economic integration with the world. This regionalization has a spontaneous nature, making the RMB de facto convertible in Southeast Asia, presenting a definite challenge to China s present capital control regime. Because China has not realized capital account convertibility, it must harmonize the processes of regionalization of the currency and RMB convertibility in order to reduce obstacles to regionalization and the financial risks involved. China must draw on the experience and lessons of the internationalization of other currencies, adjust the present capital controls and create an effective system for the outflow and return of RMB. At the same time it should work to strengthen regional economic cooperation, as well as make full use of Hong Kong in the process of realizing convertibility and facilitating regionalization. References Haruhiko Kuroda, Time for a switch to global reflation, Financial Times, 1 December. Jing Xuecheng, On basic convertibility of RMB, Journal of Finance and Trade (Caimao jingji), No.4. Wang Jian, The new stage of world capitalism and monetary system crisis. gov.cn/forum50. Wu Nianlu and Chen Quangeng, Study On RMB Exchange Rate (Renminbi huilv yanjiu), Beijing: Chinese Financial Press. Zhao Haikuan, RMB may become international currency, Southwest Finance, (Xinan jinrong), No.5. Zhong Wei, Internationalization of RMB, World Economy (Shijie jingji), No.3. (Edited by Feng Xiaoming)