Last week in Bangkok, at the annual Asia-based conference of the Pacific Pension Institute, which brings together public plan sponsors from Asia and North America, Dai Xianglong, chairman of China's $82 billion National Council for Social Security Fund (NSSF), discussed the renminbi from an investor's perspective.
Earlier that day, Fred Hu, chairman of Goldman Sachs's Greater China business, had responded to a question (from AsianInvestor) regarding the conditions under which China would free its currency. Hu said the technical requirements were in place and that this was now a question of political will.
Later, following a presentation on the NSSF's investment strategy by Dai, Hu put the same question to him. Dai (who once ran the People's Bank of China) emphasised his remarks were as an institutional investor, not a policymaker, and then proceeded to outline what he saw as the key steps that could lead to full convertibility.
The answer suggests that the authorities in Beijing don't see this as merely a matter of political will.
First, Dai noted the need for the global macroeconomic system to be reformed following the US-born credit crisis, but that realistically there was no alternative to the dollar serving as the reserve currency for some time to come. America's GDP is 25% of global GDP, but around two-thirds of all cross-border transactions are in greenbacks, giving it a dominance that won't be readily challenged.
From Dai's perspective, the dollar can be stabilised if the US government reduces its budget deficit. In the meantime, foreign institutional investors will look to diversify their foreign currency reserves. The renminbi should be part of the basket of currencies used by global investors, says Dai -- but this does not mean it will be convertible.
He reminded the audience that full currency convertibility has been the official goal of Chinese policy for the past 16 years, but this requires modifications to the domestic economy to ensure a healthy balance of payments. The nation's FX reserves are now one-third of the size of the domestic banking system, which is too big.
Domestic banking operations also need to be market-orientated and credit-focused, Dai said. There is currently a big gap (over 3%) between the interest rate at which state-owned banks lend and take deposits, which needs to be narrowed.
Dai suggested other steps could foreshadow a move towards convertibility. Foreign direct investment flows could be further relaxed, perhaps with greater flows directed to certain industries. The government could also give out more and bigger quotas for its qualified foreign institutional investor and qualified domestic institutional investor schemes.
And it could create conditions in which Chinese citizens could directly buy foreign securities. (Dai, as mayor of Tianjin, had tried to do so by announcing a 'through train' from Tianjin to Hong Kong's stock market, a plan that was quickly squashed by central authorities in Beijing.)
China should also take more steps to develop its domestic bond market, including letting foreigners invest in domestic bonds with their renminbi holdings.
Externally, Beijing can pursue additional currency-swap arrangements with other governments. There are already several such bilateral deals with a total value of Rmb600 billion ($87.9 billion). Those foreign central banks can transfer renminbi holdings from the swap to their own commercial banks, which in turn can purchase Chinese goods or transact with Chinese banks to convert the renminbi into another currency.
Dai suggested foreign central banks or corporations should be able to issue renminbi-denominated bonds in Shanghai or other mainland financial centres.
Once some or all of these events have taken place, getting more market participants to think in renminbi terms, the Chinese government could allow currency convertibility against particular foreign currencies -- most likely including the Hong Kong dollar, but perhaps including others from the Asia-Pacific region (such as Australia). Further economic integration among Asean and other regional powers would go a long way to prepare for this, Dai said.
Responding to questions about the timetable, he said this chain of events would likely play out over 10 years or longer.