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In the decades since it began its economic reforms in the early 1980s, China has experienced impressive growth rates-in some years exceeding 10 percent increases in gross domestic product (GDP). Since the reforms of Deng Xiaoping, politician and reformist leader of the Communist Party of China, more than 500 million people have been lifted out of poverty.1 Today, China is not only the world's largest exporter of manufactured goods, it is also the second-largest economy.2 Among emerging market economies and their national currencies, China's Renminbi (RMB) holds the greatest prospect for being widely used as a global reserve currency. The size of the economy-coupled with a diversified trade structure and relatively high growth rate-has provided much of the groundwork for internationalizing the RMB.
The Status of the RMB's Internationalization
An essential prerequisite for the RMB to be accepted as an international reserve currency is that residents of other nations must be willing to hold the currency as a financial asset. This will require that the currency be fully convertible and freely traded in international capital markets. The RMB is not a free currency but rather a managed currency. To be recognized as a freely convertible currency, it must perform three major economic functions:
1. Facilitate international transactions as a medium of exchange
2. Be used as an accounting unit for invoicing and international debt servicing
3. Be accepted as a currency reserve asset by Central Banks
At the moment, the extent of internationalization of the RMB is limited because China's financial markets are highly regulated, for example, through capital controls. To further internationalize the RMB, China must adopt an open capital account and liberalize capital markets. When capital is freely mobile it moves from countries with low capital returns to those with higher ones. Understandably, the imminent danger of capital flight constrains China's Central Bank-the People's Bank of China (PBoC)-from liberalizing the domestic capital market.
The internationalization of the RMB is also driven by the degree of China's exports, which require the purchase of Chinese currency.
China has been pursuing internationalization of the RMB as part of its exportdriven growth strategy. There are important benefits to internationalization: in addition to developing the export sectors of the economy, a rising RMB has enhanced China's political...