Introduction

Internationalization of Renminbi refers to the process that Renminbi acts more and more actively as an international currency and finally becomes one of the major settlement and reserve currencies in the international trade and investment activities. From a static perspective,it is the result and consequence of international use of Renminbi,and from a dynamic perspective,it involves the whole process during which Renminbi becomes a major international currency.Internationalization of Renminbi is a symbolic event of the rise of China,and it is also an important tool as China develops its economy and plays a more important role in the world.Therefore,the internationalization of Renminbi is with no doubt one of the most important national strategies of China in the 21st century.

The recent financial crisis which was rooted in the United States is changing the world's economic and financial structures.Chinese go—vernment made a series of post—crisis arrangements in order to achieve stable economic growth in uncertain international economic environments and protect its own interests from damages caused by unfair international monetary system.In 2009,China started a pilot program to use Renminbi as the pricing and settlement currency in cross border trades.As the financial services and supervision systems were improved,in 2011 China expanded the pilot domestic parties from the original five provinces to all over the country and foreign parties from east Asian countries to the global market.Also in 2011,China started experimental use of Renminbi in cross border investments and financial transactions which were regarded as a sign of deregulation in the ca—pital account supervision.Renminbi was accepted by some of China's neighbor countries and developing countries,and seven countries included Renminbi in their foreign exchange reserves.2011 was called the start year of the internationalization of Renminbi.

The internationalization of Renminbi is not purposely conducted by the Chinese government,but an inevitable outcome of economic and market development and historical evolution.Putting it in the traditional Chinese culture logic system,the internationalization of Renminbi is just a natural outcome of right timing,geographical convenience and harmonious human relations.The 2008 financial crisis revealed great systemic risks of the U.S. dollar dominating international monetary system.Thus diversification of reserve currencies becomes an international common understanding which helps resolve the problems of current system.This provides a right timing for the internationalization of Renminbi.In 2010,China exceeded Japan and became the world's second largest economy as well as second largest exporter.As China becomes one of the most important trading and investment partners,it is quite reasonable to use Renminbi as the pricing and settlement currency.And this comes with geographical convenience.Chinese traditional culture advocates ideas like “the golden mean”,“harmony between the heaven and human” and “non—war”,strengthens mutual respects and common interests,and provides cultural basis for world's peaceful developments.Chinese culture and development model are widely understood,accepted and respected,which provides harmonious human relations for the internationalization of Renminbi.With all the three important components ready,the internationalization of Renminbi has had all ne—cessary pre—conditions.Therefore,in 2011,China released an important and clear signal to the world that the internationalization of Renminbi was launched.

In order to track the process of the internationalization of Ren—minbi,identify experiences and challenges in this process,and promote its successful developments,starting from 2012,Renmin University of China publishes its Annual Report on the Interna—tionalization of Ren—minbi. These annual reports will aim to describe the up—to—date situation,identify key events and analyze their impacts and implications,study annual hot topics,propose major domestic and outside challenges and make constructive policy suggestions.

How to understand and keeppace with the process of internationa—lization of Renminbi? How to evaluate the gap between the current status and ideal targets? These questions still remain unresolved for the academia and policy makers.

Our report tries to make some groundbreaking contributions by introducing an index of internationalization of Renminbi.We hope to make this a starting point by using a comprehensive multi—variable index to reveal the degree of internationalization of Renminbi.The index values and their development trends give direct information about the level of internationalization of Renminbi.And by comparing index levels of di—fferent historical periods or among different countries,we will have more information about the extent Renminbi is accepted by the markets.It also helps review past public policy and design of relevant market mecha—nisms,and forecast future trends of developments.We believe that the index of internationalization of Renminbi will provide market practitioners and policy makers with a straight and scientific ma—nagement tool,and provide the international academia a new instrument of research.The index level rose quickly to 0.45 at the end of 2011,which was 22.5 times of the value of 0.02 at the beginning of 2010.We believe this index level was consistent with the active roles Renminbi played in settlements of cross border trades,international bond issuance,and inclusion of reserve currencies.Of course,the internationalization of Renminbi still has a long way to go,especially when we compare with the internationalization index level of the U.S. Dollar which was as high as 54.18 in 2011.

The internationalization of Renminbi involves improvements and reforms of regulations and public policies,as well as participations of financial institutions and other companies from domestic and foreign markets.In this report,we selected several key events in the process of internationalization of Renminbi and analyzed them from two perspectives,public policy and market development.And we discussed possible impacts and future developments of these events.We identified the following five events which we believed should be key events by the end of 2011: Renminbi being fully accepted as pricing and settlement currency in cross border trades,pilot cross border capital flow of Renminbi,inclusion of Renminbi as reserve currency by some countries,development of off—shore market of Renminbi in Hong Kong,and foreign exchange businesses with minor foreign currencies.

In this report we also studied some other important questions.Should liberalization of capital account controls and a sharp appreciation of Renminbi be the pre—conditions of the internationalization of Renminbi? Will the Hong Kong off—shore market of Renminbi be a hotbed of international hedge capital? This report provides the research of our team,including the roots and functioning mechanisms of these questions.Besides,we reviewed literature and opinions of government agencies,academic researchers,financial institutions and think—tanks.

To maintain the medium—and long—term value of the RMB fluctuate normally in the steady rise in the equilibrium price chanel,as well as irrational RMB appreciation is expected to disappear are the ideal situation. And liberalization of capital account is not a pre—condition of the internationalization of Renminbi.They can run parallel and promote each other.As there will be more market participants and more flexible transaction arrangements in Hong Kong off—shore Renminbi market,it is no wonder to see deviations of Renminbi exchange rates from the mainland market.Thus the arbitrage opportunities will have some outside impacts on China's money markets and monetary policies.However,we believe this will also help promote reforms of market—oriented interest rates and exchange rates.

Based on the above analysis and the challenges faced by the internationalization of Renminbi,in this report we propose the following policy suggestions.

First,the biggest long—term challenge comes from development of China's real economy.If we cannot change the current economic growth model which relies heavily on outside demands and the “smile curve” low—end income,it will be very hard for China to become a strong participant in international trades.This will make it hard for China to have enough bargaining power in international negotiations on choosing Renminbi as the pricing and settlement currency,and it will limit the room of Renminbi's appreciation.Should this be the case,it will be hard for Renminbi to be a major international settlement and reserve currency.We believe it is of key importance for China to take advantages of the precious time—window opportunity in the post—crisis period,to formulate sound macro—economic policies,to take good use of domestic and foreign resources,and to make break—through achievements in technological innovations and industrial upgrades.These are keys to economic fundamentals of the internationalization of Renminbi.

Second,the mid—term challenge comes from deficient financial system,poor financial markets,and inefficient financial institutions which will lower the competency of Renminbi.Currently China is pushing a series of reforms in its financial services industry.China should coordinate the internationalization of Renminbi with its reforms of market oriented interest rate regime,market oriented exchange rate regime,and capital account liberalization.By understanding and taking use of the inter—relationship among these four areas,it is possible to get more result with less effort and remove the mechanic obstacles of the internationalization of Renminbi.

Third,without a modern and large off—shore Renminbi market,it will be hard for China to have a high level of the internationalization of its currency.The key to successful developments of off—shore Renminbi market is to expand the size of off—shore Renminbi deposits.It is time—consuming,small scale and scattered to accumulate off—shore Renminbi deposits through trade deficits.And if we rely on huge capital investments in foreign markets,it might cause negative political consequences.We believe the most desirable way is to allow large Chinese commercial banks to expand the size of Renminbi loans in foreign markets and thus help develop the off—shore Renminbi market.

Fourth,the development of internationalization of Renminbi might introduce some outside impacts to domestic industries and enterprises.We need to pay attention to this problem and do some research and make necessary preparations.It is important to keep calm and not to push the internationalization of Renminbi in a hurry.We need to be very cautious in opening the capital account to remove capital control of one project only when all necessary pre—conditions are ready.It is more desirable to speed up the nominal capital account opening while manage the real process through technological instruments and procedure settings in order to keep the hot money within the risk tolerance limits of sound economic and financial developments.

All in all,the internationalization of Renminbi is a trend which will be pushed by economic and market forces.What our governments need to do is to make a better top level design and not to hinder its development.As China's economic transition realizes substantial achievements,and as Shanghai is developed to be an important international financial center,we are optimistic that in ten years more and more countries will use Renminbi as one of their major reserve currencies,and the internationalization of Renminbi will reach a great success.

Chen Yulu
June,2012