Geopolitical tensions and regulatory challenges hinder the renminbi’s internationalization despite China’s economic efforts and strategic adjustments.

The internationalization of the renminbi has been a central element of China’s economic strategy for over a decade. It is now the fourth most used currency (below 5%) in the world for global payments, up from 35th in 2010.

China’s official currency, the renminbi, is gaining traction in global financial markets, mirroring the nation’s growing economic clout. Key financial hubs like Hong Kong, London, and Singapore are pivotal in renminbi trading, offering offshore markets that facilitate international transactions and investments.

In Hong Kong, the currency is actively traded in both spot and forward markets, benefiting from the city’s proximity to Mainland China and its role as a gateway for international investors. London leverages its position as a global financial hub to provide a range of renminbi-denominated financial products and services, establishing itself as a leading renminbi trading center in Europe. Singapore’s strategic location and robust financial infrastructure also make it a significant player in renminbi trading, supporting the currency’s integration into global trade and finance. Other financial centers like New York, Frankfurt, and Tokyo are seeing increased renminbi trading volumes, contributing to the currency’s internationalization.

GCC diversification and China’s growing influence

A report from the Institute of International Finance (IIF) highlights that Gulf Cooperation Council (GCC) countries are gradually shifting away from the U.S. dollar, enhancing trade with nations like China and India. Currently, U.S. Treasury securities account for only 7% of the GCC’s foreign assets.

Despite the U.S. being a key geopolitical partner, China has emerged as the region’s largest trade partner. GCC nations are increasingly signing bilateral trade agreements in non-dollar currencies, exemplified by the UAE’s Comprehensive Economic Partnership Agreement with India and currency swap agreements with China. However, this shift is limited due to GCC currencies being pegged to the dollar, ensuring regional financial stability.

The IIF projects the GCC’s gross foreign assets to reach $4.4 trillion in 2024, driven by current account surpluses. Nearly two-thirds of these assets are managed by sovereign wealth funds, with investments spread across equities, bank deposits, foreign direct investments, U.S. Treasuries, and bonds. Geographically, 65% of these investments are in North America and Europe, with the remainder across Asia Pacific, MENA, sub-Saharan Africa, and Latin America.

Geopolitical tensions and economic sanctions

The escalating geopolitical tension between China and major Western powers, particularly the United States, is a significant barrier to the renminbi’s internationalization. The trade war initiated during the Trump administration has evolved into a broader strategic rivalry encompassing technology, military, and human rights issues. Tariffs, export controls on Chinese technology firms, and sanctions against Chinese officials and entities have created an atmosphere of uncertainty and mistrust, extended into 2024.

These frictions have led to a decoupling of economic ties, prompting businesses and investors to reassess their exposure to China. Companies are hesitating to hold or transact in renminbi as they seek to mitigate risks associated with economic sanctions or sudden policy shifts between the U.S. and China.

Financial market access and regulatory environment

China has made strides in opening its bond and equity markets to foreign investors, but the pace and scope of these reforms remain cautious and tightly controlled. Concerns over capital controls, real estate systemic risks, profit repatriation, and government intervention deter many potential investors. Additionally, the opacity of China’s financial system and the lack of a fully convertible currency pose significant risks. International investors require transparency and predictability, which is often lacking in China’s regulatory framework. Until these structural issues are addressed, the renminbi’s attractiveness as a global currency will remain limited. Foreign holdings of Chinese domestic bonds reached $570 billion in April 2024, a significant increase but still modest compared to the U.S. Treasury market’s near $30 trillion.

Onshore and offshore markets

The renminbi is primarily traded in two markets: the onshore market within mainland China, which is tightly controlled by the government, and the offshore market, which allows for more flexibility and fewer restrictions. Major offshore trading centers include Hong Kong, London, Singapore, and New York. Both markets operate under different regulatory environments, leading to potential differences in exchange rates and opportunities for regulatory arbitrage.

Global economic shifts and alliances

The shifting geopolitical landscape, marked by regional trade agreements like the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and the Regional Comprehensive Economic Partnership (RCEP), impacts the renminbi’s internationalization. While China is a key player in RCEP, its exclusion from CPTPP underscores the complex interplay of regional politics and further economic decoupling. Moreover, the Belt and Road Initiative (BRI), China’s ambitious infrastructure and investment project, promotes the use of renminbi in participating countries but faces scrutiny and pushback due to concerns over debt sustainability and transparency. As of 2023, BRI projects worth over $100 billion were delayed or canceled.

Impact of COVID-19 and global economic stability

The COVID-19 pandemic has complicated the internationalization of the renminbi. The initial outbreak in China and the subsequent global spread disrupted supply chains, trade flows, and financial markets. While China’s rapid recovery showcased its economic resilience, the pandemic underscored the risks of over-reliance on any single economy. Global economic stability remains fragile, with concerns over inflation, supply chain disruptions, and the uneven pace of recovery. Businesses and investors prioritize stability and liquidity, currently more associated with established reserve currencies like the U.S. dollar and the euro.

Looking ahead: Strategic adjustments and opportunities

Despite these challenges, the internationalization of the renminbi is achievable with strategic adjustments and reforms. Enhancing the transparency and stability of its financial system, implementing robust regulatory frameworks, ensuring the rule of law, and providing greater clarity on monetary and fiscal policies would build investor confidence. Fostering deeper economic ties and trust through multilateral engagements and adhering to international rule-based norms would mitigate the impact of geopolitical tensions. Building alliances based on mutual economic interests rather than geopolitical rivalry could create a more conducive environment for the renminbi’s internationalization.

Leveraging digital innovation, such as the Digital Currency Electronic Payment (DCEP) initiative, could position the renminbi as a leader in the evolving landscape of digital finance. The adoption of digital currencies globally presents an opportunity for the renminbi to gain traction as a modern, efficient, and secure medium of exchange relative to cryptocurrencies.

While the current geopolitical situation poses significant challenges to the internationalization of the renminbi, it also presents opportunities for strategic recalibration. By addressing structural issues, enhancing transparency, and fostering international cooperation, China can advance the renminbi’s status as a global currency. The journey towards internationalization may be fraught with obstacles, but with the right strategies, the renminbi can achieve a more significant role in the global financial system. China is moving slowly but surely in the right direction.