Making the RMB Convertible

Barriers to capital flow in and out of China are gradually being brought down. Convertibility of the yuan is one major step

By TAN WEI

Before Xu Bing went to Viet Nam on business, he converted some renminbi (RMB) into Vietnamese dong. When he arrived there, he found that RMB was available and in use in Viet Nam. He could pay for taxi fares or make purchases directly in RMB.

The RMB is accepted in China’s other neighboring countries, too, like the Republic of Korea, Mongolia, Myanmar, Singapore, Malaysia and Thailand. Products there are priced in both the local currency and the yuan, another name for the Chinese currency.

Circulation of the RMB in these countries basically stems from demand, which is an indication of China’s increasing economic influence in Asia. The Chinese Government has allowed people to carry RMB in and out of the mainland since March 1993. But there are restrictions, such as the amount that can be taken. RMB circulation outside China has been a totally private phenomenon. The currency is essentially convertible in these countries and regions.

If the RMB were to become a worldwide convertible currency, money could be deposited in any currency. To buy non-Chinese commodities, one could exchange RMB for foreign currencies and order them by mail, for example.

China’s bustling international trade, investment and its development of the financial market require that the yuan be convertible under capital account sooner rather than later.

Legally, at this point, Chinese nationals are not allowed to convert RMB into foreign currencies. Exceptions include international trading or going abroad to study, travel or visit family. Likewise, foreign nationals in China can’t change the money they’ve earned in the country into other tender, except for the yuan leftover that was originally converted from a foreign currency, for which a receipt is needed.

Beginning of a Process

RMB IS OK: Mainland tourists buy jewelry with RMB in Hong Kong

Exchange of currency can be divided into three degrees: inconvertibility, convertibility under the current account of international payments and convertibility under both current and capital accounts. The International Monetary Fund (IMF) has defined the convertibility under current account as the lowest level of convertibility.

In 1996, China eliminated the limits of exchange in non-trade and non-recurrent trade items under current account. The State Administration of Foreign Exchange (SAFE) subsequently lifted restrictions on using foreign exchange for private purposes and expanded the scope of providing foreign tenders. The same year, the People’s Bank of China (PBC), China’s central bank, incorporated foreign-funded enterprises into the country’s banking system for foreign exchange settlement and sale, removing some obstacles to fully liberalizing the RMB conversion under current account.

China, an IMF member, is obliged to adhere to the obligations regarding currency convertibility under current account as stated in the Agreement of the International Monetary Fund. According to Article 8 of the accord, no member shall, without the approval of the IMF, impose restrictions on the making of payments and transfers for current international transactions. Nor is any member allowed to engage in any discriminatory currency arrangements or multiple currency practices. Each member shall also buy balances of its currency held by another member.

Convertibility under capital account requires abolishment of the restraints in the convertibility of foreign exchange caused by short-term capital, foreign direct investment and securities investment. This would free the flow of capital in and out of China. In practice, some international reserve currencies are still restricted under capital account during their internationalization. IMF has no strict definition of the convertibility under capital account.

In 2000, Dai Xianglong, then Governor of the PBC, declared in a letter to the IMF that China has formally accepted the obligations of Article 8, representing the RMB’s full convertibility under current account of international payment.

MONEY ON HAND: It is increasingly convenient for mainland tourists to change RMB in Hong Kong

Chinese economic planners’ efforts to deregulate its capital account have continued this year. The PBC announced in November that from December 1 emigrant Chinese or their heirs could transfer their personal property to the place to which they immigrate. The PBC sees this as not only a government measure to protect personal belongings, but also a liberalization of the capital account.

After the PBC raised the interest rates of the RMB on October 29, international speculative funds betting on the RMB’s appreciation against the U.S. dollar flew again. This added pressure on the PBC to let capital flow out of China on a larger scale. Experts say that, in finance, transferring personal property can alleviate the pressure of RMB revaluation.

Ma Delun, Vice Administrator of SAFE, indicated that, to keep away financial risks, SAFE will further lift restrictions on capital account to gradually make the RMB convertible. Ma said that SAFE has been researching administrative policies regarding the capital account, which will be promulgated soon. Research is being conducted on schemes of domestic funds investing in foreign capital markets. SAFE and relevant departments have drafted rules, including the implementation of QDII (qualified domestic institutional investors), overseas investment of social security funds and the use of capital from insurance companies.

“The application for the capital from insurance companies to invest in overseas capital markets that we have drafted has been approved by the State Council. The China Insurance Regulatory Commission and SAFE are cooperating in establishing concrete plans,” Ma said. SAFE has also been investigating the administration of foreign exchange funds of foreign companies.

Timetable to Convertibility

DOMESTIC EXCHANGE: A customer converts RMB into foreign exchange at the Shanghai Branch of the Bank of China

Since 1994, the value of the RMB has been stable. The exchange rate between the RMB and the U.S. dollar has been pegged at 8.28 yuan to $1. During the same time, China’s gross domestic product has grown about 8 percent a year. The yuan has not moved, while the exchange rate is accordant with IMF requirements of convertibility.

A booming economy, especially in foreign trade, and a favorable balance of payments, has contributed to RMB stability. Current financial reform has adjusted the exchange rate system and the foreign exchange market is on its path to the internationalization of the RMB.

Economists forecast that China’s economy will continue to grow around its current pace for the next 10 years, which could raise the international credit of the RMB. It could also lay a foundation for wide global use of the currency.

However, there is still much that needs to be done for the RMB to become a convertible worldwide currency. Obstacles include its inconvertibility under capital account, the underdevelopment of the financial market, the sustainable economic development and the immaturity of the financial management system.

Guo Shuqing, Administrator of SAFE, said that the RMB will be convertible in five or six years for about 70 percent of the 43 capital transaction items under the IMF classification.

According to international convention, even if the RMB is convertible under capital account, China can still restrict the flow of certain short-term speculative capital. These restraints will be eradicated over the long term, Chinese economic planners have said.

Zhang Yansheng, head of the Institute of Foreign Economy Studies under the National Development and Reform Commission, reckons that China has just begun financial reform and there are “more than 20 items” still unresolved. RMB could be convertible by about 2010, Zhang, like Guo, estimated.

Some economists think that before the RMB becomes an international currency it will become a regional currency.

Steven N. S. Cheung, a economist from Hong Kong, suggests that Hong Kong and Macao use the mainland’s currency. The HK dollar used to be available in nearby Shenzhen, Guangdong, in the early days of China’s reform and opening-up policy. There were even shops that would only take the HK dollar, which underscored the economic gap between Hong Kong and the Chinese mainland.

Two decades later, the RMB is pushing into Hong Kong and China’s other special administrative region, Macao. Widespread RMB circulation in Asia, while aiding research, can only accelerate its eventual universal convertibility. Widespread use of the yuan in the region will also facilitate the formation of a Chinese economic fold. Chinese business people can use RMB to buy goods and services from surrounding countries, which will facilitate business development and regional economic integration.

There are risks of RMB circulation in East Asia. What if overseas Chinese get RMB and bring it illegally into China to invest in the domestic capital market? Or if they illegally exchange investment earnings into U.S. dollar or other currencies and take them out of China? This would be a loophole in the administration of China’s capital account. During the process of making the RMB convertible, the entry of illegal speculative funds should be strictly controlled.