As China's economy gets bigger and more competitive, the country will play a greater role in the international financial system. The yuan's internationalization is an inevitable trend despite hardships along the way.
Countries like the US have been pursuing protectionism and unilateralism in recent years. The China-proposed Initiative (BRI), on the contrary, enhances trade facilitation and boosts development of the financial industry along the BRI route. In the past six years since the BRI was proposed, more countries and companies have seen opportunities from it. The BRI is in line with globalization.
The BRI will experience three phases. The first phase is building infrastructure. The second is to conduct capacity cooperation and the last phase is monetary cooperation. The three phases can overlap.
Financial innovation has been sprouting in the internet era. The yuan‘s internationalization should not only closely follow the cryptocurrency trend, but it also needs to focus on actual trade transaction settlements.
Cross-border transaction settlements should start from trade with neighboring countries. Since the reform and opening-up, the quoting and settlement system of the exchange rate in China has been centered on the US-dollar-based international financial system. Transaction settlements in trade between China and other non-US dollar countries were computed through cross rate.
As the Chinese economy expanded, neighboring economies recovered gradually from the 1997 Asian financial crisis, and several developed countries experienced the US sub-prime mortgage crisis and European debt crisis, the market base of the exchange rate formation mechanism between China and its neighbors has taken shape. Thus, cross-border financial settlement has emerged.
A vigorous financial settlement along the border is a challenge to the traditional reserve and settlement system based on the US dollar. It will also be an opportunity for China and its neighbors. Pragmatic entrepreneurs should face the reality of China‘s economic size and view the US dollar system objectively. They should adopt the cross-border settlement system and US dollar system comprehensively, as well as the newly-risen cryptocurrency. Together, a new monetary system that is more open to the BRI is starting to form.
As for the Chinese monetary authority, one effective method to promote the yuan‘s internationalization is the application of cross-border internet payment and settlement. By extending foreign exchange centers to areas that share borders with neighboring countries, the yuan exchange rate formation mechanism can connect with neighboring countries.
For example, establishing a branch of the China Foreign Exchange Trading System in Northwest China‘s Uyghur Autonomous Region would help deal with currencies in Central Asian countries. A branch in Northeast China‘s Heilongjiang Province can deal with currencies in Northeast Asian countries. The financial reform pilot zones in Southwest China‘s Yunnan Province and Guangxi Zhuang Autonomous Region can deal with currencies in Southeast Asian countries. This way, it is possible to bypass the cross rate calculated using the US dollar.
The Currency Regional Trading Information Platform was launched in August 2018 to provide information on the interbank market and over-the-counter market. The platform will make information on regional currency transactions public and transparent. Information on the foreign exchange market will be better shared to help financial institutions and firms settle bilateral currencies with greater efficiency, and thus step up trade and investment facilitation.
The People‘s Bank of China issued a scheme in 2013 to construct financial reform pilot zones in Yunnan and Guangxi, fostering financial cooperation with and South Asian countries. Within the zones, it offers yuan-denominated loans and financial instruments.
According to the scheme, attempts will be made to set up the yuan-denominated overseas investment fund. When the time is appropriate, transactions between the yuan and other currencies of neighboring countries should be made on a regional interbank market.
Internet giant Facebook announced plans to create Libra, a new cryptocurrency. The scheme of China‘s regional financial pilot zones can serve as a reference for Libra. As the 21st Century Maritime Silk Road goes deeper, China and ASEAN countries have large-scale cross-border transactions in trade and tourism sectors. There is a huge demand for real-time settlement in electronic transactions. Chinese internet giants such as Tencent and Alibaba have built up an exclusive and closed transaction chain. Not all the financial regulatory bodies in ASEAN countries embrace the trend.
Financial construction along the border is needed. While China communicates with ASEAN on political and diplomatic levels, it can also organize communication with central banks and regulatory bodies in ASEAN countries. The operation and organizational structure can learn from Facebook‘s Libra.
Against the backdrop of cryptocurrency competition, China has to catch up with tangible financial sectors and free itself from the cage that the US dollar system has put on international trade.
On the other hand, China can study the organizational structure of Libra. It will have to cooperate with cross border transaction institutes from Europe, the Middle East, Southeast Asia and Northeast Asia with market-orientated operation. By developing a digitalized yuan cross-border transaction market, the regions will stand on solid ground to face Libra.
The author is chief advisor of China Securities JT Fund and global research partner of Anbound Think Tank.