Author: Gregory Chin, York University and CIGI

Without political fanfare, China took two more steps in internationalising its currency in early December 2012.

On 4 December, trading giants South Korea and China agreed to use their currency swap, valued at US$59 billion, to boost bilateral trade using the yuan and the won. On 12 December, Chinese central bank authorities awarded the Bank of China’s Tapei branch the role of clearing bank for yuan transactions in Taiwan. In turn, the Bank of Taiwan’s Shanghai branch will clear transactions on the Chinese mainland. Although market fundamentals will ultimately determine the viability and sustainability of the renminbi as an international currency, these agreements highlight that politics matter.

Politics also features in holding up another dimension of Chinese currency internationalisation: with Japan. On Christmas Day a year ago, China and Japan signed the agreement for ‘Enhanced Cooperation for Financial Markets Development between Japan and China’. It included wide-ranging currency cooperation arrangements to promote the use of their currencies for trade and investment. Both countries wanted to reduce costs and risks for their companies — and implicitly called for less reliance on the US dollar, currently their predominant medium of exchange. Japanese authorities also confirmed a plan to buy the equivalent of US$10 billion in Chinese government bonds, marking the first time they added renminbi-denominated assets to Japan’s official reserve holdings.

The significance of the pact lies in the fact that together, China and Japan hold the world’s largest foreign-currency reserves, with China holding about US$3.2 trillion and Japan US$1.3 trillion at the time of the agreement in December 2011. Any moves to reshuffle those holdings would change the global currency map.

During the first half of 2012, the Joint Working Group for Development of Japan–China Financial Markets, established to flesh out the details of the bilateral agreement, made significant progress. By June 2012, direct trading of the yen–yuan commenced on the Shanghai and Tokyo exchanges.

Recent visits by the author to Tokyo and Hong Kong in December 2012 have highlighted that one of the overlooked casualties of the ongoing island dispute between China and Japan is their currency pact. Further implementation of the agreement has stalled. The Working Group has stopped meeting due to the political fallout. The offer from the Japan Bank for International Cooperation to sell an undisclosed amount of renminbi-denominated bonds on mainland markets remains in limbo, awaiting formal Chinese approval — after being listed as a pilot program in the agreement signed on 25 December 2011.

The amount of Sino–Japanese trade that is settled in yuan and yen remains low; nearly 60 per cent of China–Japan trade continues to be settled in US dollars. Given the continuing importance of the United States as an end market, and other forces of habit that produce inertia, Japanese traders remain reluctant to accept renminbi for their exports to China, and continue to prefer the US dollar as the settlement currency of choice. Conversely, Japanese companies continue to convert their yen into US dollars when buying from China. The business incentive to convert to yen–yuan settlement also appears lacking, especially for the large Japanese trading companies, as the cost of settling in US dollars remains low.

Yet, coming out of the 2007–09 global financial crisis, central banks and finance ministry officials in Beijing and Tokyo declared a desire to promote diversification in international currencies. More recently, they have been joined by some of their neighbours in the region, namely Malaysia and South Korea, which are also taking initial steps to promote the use of their national currencies internationally. But the territorial dispute between China and Japan has diverted attention from currency cooperation.  

If promoting international currency diversification remains a priority, then both sides ought to embrace their recent leadership changes as an opportunity to hit the reset button. More broadly, in the interests of international stability and cooperation, both sides need to put the crucial China–Japan relationship on more solid footing. Beijing’s offer of ‘joint development’ of the resources around the disputed islands is a positive step.

At the same time, newly returned Japanese prime minister Shinzo Abe should remind the public that Japan’s recovery during the past decade has been intimately tied to surging trade and investment ties with China.

Regarding currency cooperation efforts, Japanese finance officials offered two related suggestions during the recent research discussions in Tokyo. First, they reiterated that recent leadership changes in Beijing and Tokyo, and further imminent changes on the Chinese side, present an opportunity for both sides to adjust and re-establish relations and to reduce tensions.

Abe may have initiated this shift by offering reassuring statements at his first press briefing after election day, when he told a Chinese Xinhua reporter that Japan–China relations are ‘one of the most important bilateral relationships’ and he pledged to improve bilateral relations. He further emphasised that China is an indispensable country for the Japanese economy to keep growing, and noted that ‘we need to use some wisdom so that political problems will not develop and affect economic issues’.

Second, Japanese finance officials noted rather hopefully that Japan and South Korea also experienced territorial disputes in the past — but that once the disagreements were dealt with, it did not take very long before finance ministry representatives from both sides resumed their talks, picking up where they left off. The same might be said for the resumption of the China–Japan Joint Working Group.

Gregory Chin is Associate Professor at York University, Canada, and China Research Chair at The Centre for International Governance Innovation.

1. The renminbi’s rise as an international currency: historical precedents
2. The renminbi as a global currency?
3. The valuation of China’s currency – Special editorial

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Currency internationalisation in Asia