Comments on: The Renminbi’s Ascendance

in International Financeby

Eswar Prasad

2015 Asia Economic Policy ConferencePolicy Challenges in a Diverging Global Economy

Federal Reserve Bank of San Francisco, November 19-20, 2015by

Stijn ClaessensSenior Adviser, Federal Reserve Board

Disclaimer!

This presentation represents my own views and not necessarily those of the

Federal Reserve Board of Governors or its staff.

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Question and Answer of Paper

Q: What is/will be RMB’s role in global monetary system and government’s role in it? Will RMB become an international and reserve currency?

A: RMB is on track to become important Policies are supporting greater role of RMB Increased use of RMB international, including likely SDR

But there are constraints and risks Limited financial sector development, liberalization Phasing of policies, politics, and dollar dominance

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1. Relevance of and praise for paper

Surely a worthwhile topic, also for policy Know little on what drives a currency to be

international or global. Interesting “case study” Many focused on this, financial markets, (international)

policy makers, etc. Many (international) repercussions Praise and agree with main findings

Careful (historical) review of facts and steps so far View consistent with others’ (many here!), but not all

Given success, hard to question China’s approach

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Also hard to disagree with world’s expert on this. Quotes of Prasad:

“Yuan inclusion in SDR good for financial mkt reforms in China and IMF's legitimacy” @S_Rabinovitch in The Economist“The yuan's int'l value will be determined by the market, but this could help spur reforms in China” @EswarSPrasad in WSJ Editorial page“China's RMB stays on track to get into IMF's SDR basket—a zig-zag path to an outcome that seems foreordained” @sdonnan in Financial Times“How China's currency move could elevate RMB's stature in global finance” @JimZarroli at NPR

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2. Comments: Stock-taking vs. Viewand Collateral Benefits

Mostly stock-taking, not review of goals or paths Paper informs on where China/RMB is in number

of important dimensions, given the stated goal(s) “China/RMB appears on path in most respects”

But would have like to have seen a review of goals And relies heavy on “collateral benefits” view

Stepping the stones provides benefits, but..1. Are they really as large as thought (before GFC)?

Experiences of advanced countries make for a rethink?2. Are all steps consistent with maximize “learning”?

Some more for narrow/private than collateral benefits? 6

Quibbles on the stock-taking“Half Full or Half Empty”

Official reserves are large, but.. Maybe not good measure of “internationalization”

Openness is increasing, but.. In vs. outwards, and who can go in/out is selective

Openness vs. control, debt vs. equity (majority).. Open to flows is not equal to granting full market

access, notably in finance, e.g., foreign banks Cash-flow vs. control rights, e.g., A,B,H shares

Exchange rate management freer, but… Regime still not so transparent (e.g., off-shore)

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More Quibbles Financial development: high or low?

# are large, quality is less so Fiscal position strong today, but tomorrow..

Financial system is very large, (credit) growth remains high → contingent liabilities could be large

FX reserves and Greenspan/Guidotti rule SDR, yes, will happen, but..

Benefits and did it accelerate reforms in good ways? Recent policies can make one wonder on path..

Stock market gyrations; Exchange rate devaluation; Shadow banking system; Interest rate liberalization

Do not fully fit with overall deliberate strategy 8

3. Stepping BackAn Attempt at Analytical Framing

Three questions can be/have been ponderedi. Can RMB internationalize, become reserve currency?ii. Should RMB internationalize? Costs vs. benefitsiii. How to internationalize? What is the (best) path?

“Definitions:” Internationalization: greater use of RMB. Reserve currency: (large scale) store of value; unit/medium of account/transactions/invoice

If yes to i and ii, then iii steps, relative or absolute What matters more? What now? What can wait? How to

balance? What else to do? How to maximize gains? Paper could do a review of the literature to date

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i. Can RMB int‘nalize/reserve?List of others vs. Prasad’s

Angeloni et al, ECB, Eichengreen,Kawai, Goldberg, Frankel, etc.

Prasad

Size, Economic Strength, Share of World Economy, Trade, etc.

√√√ √√Strong Financial markets √√√ √Reliability of Rules √Quality and Predictability of Fiscal and Monetary Policies

√√ √Ability to Respond to Unexpected Shocks

√ √Political Cohesion √√Network Externalities Persistence, Hysteresis

√

Mountains, Island, Army… √10

Can RMB int‘nalize and reserve?Other views are more cautious

Most: both will take some time and effortsFrankel (2011): “long way to go” “policy defy logic of political economy” “sequence unorthodox”; Eichengreen(2015): “not in one day” “not without risk” “regional vs. international/global.” Eichengreen and Kawai (2015): many steps; Goldberg (2012): reserve currencies have path dependency, persistence of dollar. Prasad (2014): Dollar trap

Key to Internationalization is policy coherence Key to Reserve is stability of domestic markets,

esp. gvt bond. Is China’s large, stable enough?11

ii. Should RMB internationalize?Gains and Risks, and for Who?

Gains Risks

• Benefits for local financial markets development and monetary policy

• More general learning• Better scope for diversification,

insulation from shocks, less valuation effects

• Lower cost of funding (debt)• “Seignorage”• “Global influence”

• Challenges managing internal and external balances

• Spillovers, importing of global financial cycles,

• Financial instability (“We are not in Kansas”)

• Hard to reverse policies (easier to lose than to gain)

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Should RMB be a reserve? Also given costs, others have said “no.” So maybe?

Reserve currency comes with some “costs” Demand volatility due to “safe haven,” as in GFC Demand and need to internalize monetary policy Δs Responsibilities: Maintain swap lines. Ship cash.

Have settlement. Help with RMBization. Etc.

Japan, Germany were reluctant to “reservize” Frankel (2011): “costs outweigh benefits” Also optimal timing can be “elusive:” inflation,

exchange rate dynamics, financial stability, etc.13

iii. How to internationalize (RMB)?Other evidence suggests caution

Evidence on what works (caveat China is unique) Other (capital account liberalization) experiences

suggest can be very complex, more than presented Needs overall consistent approach, starting with

domestic financial market development, not just size Economic liberalization and political liberalization

Also “Institutional View” of CAL, CFM, MAP Integrated approach: sequencing, consistency, etc. Important to have/keep macroprudential and capital

flow management policies in place (cannot reverse

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Recent experiences and thinking thus suggest some “lessons”

Focus more on risks along path and policies Recognize irreversibilities, and slow some reforms How to prevent a Chile 1979-82? East Asia crisis?

Integration is not just about cross-border flows Also need committed capital, foreign banks present As per experiences of euro, Eastern Europe, others

Build in more explicitly learning E.g.,: support of ER, allow for (selective) exit do not

encourage learning. How RoR on assets > liabilities? Experiment with small, reversible steps first?

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4. Theme of Conference: “Policy Challenges in a Diverging Global Economy” Divergence and global financial stability

Would rise of RMB make system more less stable? Yes, means for easier/better global risk-sharing But also greater risk of tipping, booms/busts, due to market

failures, externalities, bubbles Policy implications as regards ROW

What to do, if anything, ex-ante Greater swaps (but effective?) Better infrastructure?

What else is needed eventually, in Asia? Full financial integration w/ BU, to avoid financial trilemma Interim smart MAP/CFM, instead of ring-fencing

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Summary of comments State of play

Half full vs. half empty? Many possible quibbles..

Collateral benefits, learning, consistency Too optimistic? And following best processes?

Openness vs. market access. Control vs. cash-flow rights. Is the balance right?

Overall goal of full openness Worth to revisit in light of experiences? MAP/CFM

International aspects and repercussions Many implications, deserving more thought

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