In August, 2010, China began a pilot program in Hong Kong to offer channels for foreign investors to buy Renminbi (RMB) assets. The program, currently still limited to bonds, allows holders of offshore RMB deposits to invest in China's A-share stock market. Back in May 2008, the State Council allowed two Hong Kong-registered financial institutions -- HSBC and Bank of East Asia -- to issue RMB-denominated bonds.

The moves by the Chinese side signal a significant step in China's foreign exchange policy towards developing an offshore currency market and supporting the internationalization of RMB. Echoing the Hong Kong measures, China also agreed six currency swap agreements with Argentina, Belarus, Hong Kong, Indonesia, Malaysia, and South Korea. Since the G-20 summit in November 2008, the People's Bank of China(PBOC) has signed bilateral currency swap arrangements totaling RMB650 billion ($95 billion), including a framework agreement signed with the Bank of Korea involving RMB180 billion in December, 2008; a formal agreement with the Hong Kong Monetary Authority involving RMB200 billion in January, 2009; a formal agreement with Malaysia involving RMB80 billion in February, 2009; formal agreements signed in March 2009 with the National Bank of the Republic of Belarus involving RMB20 billion, and the Bank of Indonesia involving RMB 100 billion; and a framework agreement signed with the Central Bank of Argentina involving RMB70 billion. By signing these currency swap agreements, China and its partners can bypass the dollar as a medium of exchange in bilateral trade.

Against this backdrop, it's clear that the Chinese government aims at internationalizing its currency by developing an offshore Renminbi market and promoting the use of the Renminbi around the world.

The Chinese motivations are clear. First, the U.S. budget deficit ballooned as a result of the global financial crisis. U.S. Secretary of State Hillary Clinton has called the budget deficit "a serious national security issue." With the growing deficit and the Obama administration's loose monetary policy, the value of the dollar is expected to fluctuate and weaken substantially. The Chinese government is seeking ways to internationalize its own currency and reduce its reliance on the dollar as a medium of exchange. Moreover, given the dire economic environment in the U.S., unemployment there also rose dramatically. U.S. legislators sought a scapegoat to explain the huge job losses to their constituents, and China was an easy target. Legislators could attribute job losses to the trade deficit with China and, in the last analysis, to Chinese "currency manipulation". Therefore, the Chinese leadership already in 2008 had good reason to anticipate that the relative decline of the U.S. economy would result in pressure on China to appreciate its currency. Given this expectation, it was in China's interests to launch a "rhetorical preemptive strike" by openly talking the dollar down and announcing high-profile steps to internationalize the Renminbi, since this would force U.S. to focus on defending its own position and making guarantees to the international community about the stability of the dollar, rather than on pushing China to appreciate its currency.

Though the Chinese government clearly wants to raise the profile of Renminbi and, in the long run, make it an international currency, there appears to be no predetermined roadmap. Rather, the leadership appears to be taking Deng Xiaoping's advice to "cross the river by feeling the stones", by cautious implementation of pilot schemes in selected cities, before rolling out the experiments to other areas. In April, 2009, the government launched a pilot program to allow cross-border trade deals to be settled in Renminbi in the five coastal cities of Shanghai, Guangzhou, Shenzhen, Zhuhai and Dongguan. Whether similar arrangements will be introduced in other areas will depend heavily on the outcome of these experiments.

The government has good reason to be cautious. If it wants the Renminbi to become an international currency, residents of other countries must be willing to hold the Renminbi as a financial asset, which implies the currency must be traded freely on the capital markets. To achieve this goal, the government needs to open up China's capital markets, allow full convertibility of the Renminbi, and move to a floating exchange rate regime. This is not feasible under the current economic conditions since the Renminbi remains pegged to the U.S. dollar and is not convertible in capital account transactions. And for the foreseeable future, the government will not be able to open up the capital markets. Given the growing trade surplus over the past ten years, and the fixed exchange rate regime, there is already a growing amount of Renminbi circulating in China's economic system. Opening the capital market would probably result in a sharp depreciation of the Renminbi, and consequent macroeconomic instability. Therefore, though the government has taken steps to pave the way for Renminbi to become an international currency, China is still long way from realizing this goal.

The author is a researcher with the Freeman Chair in China Studies, Center for Strategic and International Studies (CSIS) and a PhD student in policy studies at the University of Maryland, concentrating on international security and economic policy.

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