The Taiwan Banker

China is now the world's second largest economy and increasingly active in global trade and finance. As a result, its currency, the RMB, is increasingly important. In 2016, the International Monetary Fund (IMF) put the RMB in the basket of currencies that make up the Special Drawing Right (SDR), along with the US dollar, euro, pound sterling and Japanese yen. The RMB's weight in the basket is greater than that of the Japanese yen and British pound. While some countries are gradually accumulating foreign reserves in RMB, it will take some time before the RMB becomes a major global reserve currency. China is the world's second largest economy. According to WTO data, it is the world's top merchandise exporter, its $2.98 trillion in merchandise exports in 2016 accounting for 13.2% of the global total. China is also the world's No. 2 merchandise importer, its $1.59 trillion merchandise imports acounting for 9.8% of the global total last year. China's total merchandise trade volume is $3.71 trillion, second only to the US's. As of the end of 2016, the total market capitalization of the Shanghai and Shenzhen Stock Exchanges was $7.32 trillion, second only to the market cap of U.S. exchanges. Deal value in China's stock exchanges is No. 3 in the world after the US and Japan. From the standpoint of both inbound and outbound investment, China is one of the top markets in the world.No country has a large amount of RMB reserves According to SWIFT statistics, as of December 2016, the RMB ranked sixth in global payment currency weight at 1.68%, much lower than the U.S. dollar at 42.09%, the euro at 31.30%, the pound sterling at 7.20%, the Japanese yen at 3.40% and the Canadian dollar at 1.93%. Previously, the RMB was No. 5 at 2.31% in December 2015. By April 2017, it had fallen to seventh place: 1.60%. In late March, the IMF listed the RMB in its currency composition of official foreign exchange reserves (COFER) data for the first time. COFER data is drawn from IMF member countries, non-member countries or economies, and other foreign institutions that have foreign currency reserves - a total of 146 entities. As of the end of 2016, among foreign reserve currencies in these 146 countries and institutions, the RMB totaled $845.1 billion, accounting for just 1.07% of the 9 types of currencies (U.S. dollar, euro, RMB, Japanese yen, pound sterling, Australian dollar, Canadian dollar, Swiss franc, and others).The latest COFER data (from the end of June) shows that the total amount of RMB held by countries as a reserve currency in the first quarter was $823.6 billion, just 0.93% of the total reserve currencies. Thus, the RMB is less important in global payments and as a reserve currency than in general trade and finance activities. To be sure, some countries have said in recent years that they are using the RMB as a reserve currency, such as the UK, Nigeria, Russia and Singapore. The EU central bank said in a June statement that it would buy 5 billion yuan to use as currency reserves. Still, it will take some time before the RMB can become a major reserve currency. The corresponding chart released by the IMF on June 30 shows official statistics for combined foreign currency reserves. The Chinese government still interferes with the RMB's exchange rateThe reason why then renminbi is still not a major reserve currency is that China's capital controls remain stringent - despite some efforts in recent years to internationalize the yuan. Beijing still partially manages the RMB's exchange rate, which makes it inconvenient to use in global trade, payments, investment and as a reserve currency. In July 2005, China began using a managed floating exchange rate mechanism for the RMB. There have been additional reforms since, such as loosening the trading band for the renminbi, US dollar and other foreign currencies and changing the yuan's fixing mechanism. Still, the People's Bank of China continues to exercise significant control over the RMB's exchange rate. In May, the People's Bank of China announced it would adjust the formula for calculating its daily yuan reference rate, the mid-point rate from which the yuan is allowed to trade up to 2%. In practice, this gives Chinese authorities more influence over the yuan's fixing and reduces the role of market forces. The PBOC did this in order to prevent further yuan depreciation. Yet this new fixing mechanism is less transparent than the previous one and introduces increased unpredictability in the fixing. It's a step backward for financial reform. Opening the capital account Another important component of RMB internationalization is opening the capital account. In this area, China has made some important strides, such as launching RMB cross-border trade settlement and direct RMB investment and financing. It has also loosened restrictions on firms bringing RMB into China and taking it out of the country, set up experimental free-trade zones, signed currency swap agreements with many countries and rolled out the One Belt, One Road policy, which aims (as one of its objectives) to further internationalize the RMB. The Qualified Foreign Institutional Investor Program (QFII) allows certain licensed international investors to participate in mainland Chinese stock exchanges. The Renminbi Qualified Foreign Institutional Investor (RQFII) program permits foreign investors with the RQFII quota to directly invest in China's bond and equity markets. The Qualified Domestic Institutional Investor Program (QDII) permits qualified mainland Chinese banks, mutual funds and other investment companies to invest in foreign securities.In Nov 2014 the Shanghai-Hong Kong Stock Connectlaunched. It provides global investors with a link to China's stock markets and mainland investors access to Hong Kong listings. The Shenzhen-Hong Kong Stock Connect launched in December 2016, providing foreign investors with another way to invest in China's stock markets and increased opportunity for Chinese investors in Hong Kong equities. In June MSCI announced that from June 2018 it will put China A shares in its emerging market index and global index, representing a milestone for the internationalization of China's capital markets. Further, beginning in August 2010 the PBOC permitted three types of institutions, including overseas renminbi clearing banks, to invest in China's interbank bond market. From September 2015, the PBOC began allowing foreign institutional investors to invest in China's interbank foreign exchange market; in February 2016 it began allowing individual foreign investors to invest in its interbank bond market, with no limitations on their investments. From February 2017, foreign institutional investors were allowed to use offshore derivative tools to hedge. On July 3, Hong Kong and China launched a bond trading link, showing China's determination to further open up to foreign investment. Capital outflows affect speed of reformStill, restrictions will remain on China's capital and exchange rate in the foreseeable future. China's capital markets will remain non-transparent and unstable. The government will continue to actively manage the exchange rate. Restrictions on remittance of funds in and out of China will remain. Market access and the relaxation of business negative lists also take time. China's 12th Five-Year Plan said that the country would gradually open the capital account in the years leading up to 2020. But following several years of continuous depreciation of the RMB, significant capital outflows and instability in the financial markets, reform has stalled. It is unclear at this point when China will be able to fully liberalize its financial sector. Thus, it will take a long time for the renminbi to become a major reserve currency.