The latest trade figures settled in renminbi have shown a surge in the currency’s share of trade finance. Data published by Swift show that the renminbi now accounts for 4.5% of the market, up from less than 2% a year ago. Many have called this the beginning of the demise of the dollar. Instead, this is the beginning of fragmentation of the multilateral clearing system based on the dollar.
While it is natural to avoid using a vehicle currency such as the dollar for trade transactions among non-US countries, this calls into question the multilateral clearing system with the dollar at its core. This allows non-US countries to use excess dollars, either onshore or in eurodollar markets, for clearing current account transactions as well as financial account transactions with other countries.
Geopolitical tensions, western sanctions on Russia and rising dollar interest rates highlighted the need for using national currencies to clear payments for trade. However, this requires a network of bilateral clearing arrangements. The European Payments Union founded in 1950 was a successful example of how to integrate various bilateral clearing systems. There are now several countries lining up to use the renminbi in their trade with China. Russia was the first notable case after it was sanctioned by the West and was no longer able to use Swift.
In addition to Russia bypassing sanctions by bilateral clearing with China in renminbi, Saudi Arabia has agreed to clear oil imports by China in renminbi. Now Brazil is asking for a similar arrangement to boost its agricultural exports. This works well as long as there are no imbalances in trade. Any excess holdings of renminbi by Russia, Saudi Arabia or Brazil cannot be freely used in trade with other countries. Adding them to the foreign exchange reserves requires investment in onshore or offshore renminbi instruments. Russia has substantially increased its share of renminbi reserves.
However, using renminbi as a store of value is different from using it to settle trades as it is highly engineered. China allows foreign central banks’ investments in renminbi to be liquidated and repatriated. The same applies to other institutions by awarding them the status of qualified foreign institutional investor even as foreign exchange regulations are in force. It is understood among partners that inward investment in China cannot be easily reversed. This is a far cry from the deep and liquid dollar financial markets, either onshore or in eurodollar markets.
For the renminbi to assume a true international role the following changes are needed. To employ renminbi from current account surpluses, China needs to allow non-Chinese parties to clear their trade in the currency. Equally, renminbi supplied under swap arrangements need to be freely convertible into other currencies. This will require a clearing infrastructure similar to the EPU. Second, obstacles between onshore and offshore renminbi markets need to be removed. Presently, the People’s Bank of China intervenes regularly in the offshore renminbi market to reduce interest rate and exchange rate differentials.
Some countries are attempting to establish renminbi multilateral clearing systems. This would happen only by linking various national central bank digital currencies or using one vehicle currency, such as the digital renminbi. Both options are being widely discussed but are far from reality. Using digital currencies does not solve the problem of moving from bilateral to multilateral clearing.
In the absence of such a breakthrough, China and its trading partners will relapse into bilateral clearing, furthering the fragmentation of the global financial system. Increased use of renminbi in world trade will not by itself ring in the demise of the global role of the dollar.
Herbert Poenisch is Senior Fellow, Zhejiang University, and former Senior Economist, Bank for International Settlements.