Internationalization of Chinese Yuan and its implications on Global Finance Harvard Case Solution & Analysis

Q1. Potentials of RMB as an international Currency:

            An international currency can be acceptable outside the home country as a medium of exchange. Although that currency cannot overlap the local currency of individual countries but it is acceptable at limited places for medium of exchange. International currency can be used for storage of value as many local banks of countries to reserve international currency. The currency is acceptable for import and export transactions of countries; therefore it can be used as a transaction motive (Parkash, 2010).

            China is now the second largest country of the world as measured in nominal GDP and it is first in purchasing power parity (PPP). It is the largest trading partner of many Asian countries and an important place for Foreign Direct Investments (FDI)(world GDP ranking).

In the previous global economic downturn, USD weakened international financial market. Such change in USD has prompted a search for a new global reserve currency. Chinese authorities are now taking steps to bring their currency as an international currency about internationalization of their RMB.

            China is one of the fastest growing economies of world that has been relatively less affected by last financial crisis of the world in 2008. After the financial crisis there was a debate that Euro must be the international currency but after that China taken its steps forward for internationalization of RMB due to its fast growing economy.

            Internationalization of RMB increases the use of Chinese cross-border transactions and overseas transactions. Through internationalization Chinese currency can be heldby international residents and used for transaction motives on international trade.

            China is the place where every international company is willing to invest due to its labor quality and available quantity with a reasonable wage rate as compared to other manufacturing countries of the world.

            Chinese economic growth has influenced the world’s economy since three decades due to manufacturing power of its labor force. China is not only growing with the help of native investors but also it accepts a huge foreign direct investment every year from many international investors.

            There is a requirement of full convertibility of a currency to play a significant role in international trade and financial crisis. The internationalization is ultimately determined by market forces that are given below;

  • The size of the economy matters for internationalization of currency. A large domestic economy can allow exploring and reinforcement of economies of scale and economies of scope involved in using wide range of domain. China is second largest economy in terms of GDP, therefore it meets its first criteria for having large domestic economy.
  • Second thing that is required for internationalization of currency is size and development of financial markets. The international currencies are usually associated with large liquid and open financial markets. Large financial market gives more access on investments and borrowing opportunities to allow effective arbitrage owing a low cost. London has the most advanced and developed system of financial market and China is behind many major economies like US and other European and Western countries.
  • Third condition is the stable value of the currency. The international currency is to be held by many countries as a store of value therefore its exchange rate must be stable.Inflation affects the stability and purchasing power and exchange rate volatility are the two measures that affect the stability of currency. The inflation rate of China is 1.1% over past decade which is lower than 2.6% of US, 2.0% in Euro, and 2.8% in UK. The volatility of RMB is very close to US but lower than Euro and GBP. It has lower level of inflation arte and acceptable rate of volatility for being an international currency.
  • Last condition is network externalities; in that the currency is not only used by native people but also by the people around the world so the currency must be convincing to those other people of the world using currency for their transaction, unit of account and value to store motives.

Internationalization of Chinese Yuan and its implications on Global Finance Case Solution

(Chen, 2009)

            Internationalization of a currency is done by market drivers; if international market drivers do agree on making a currency an international currency then its process can proceed. RMB is under benefit because of free economy of China and high exports and foreign direct investment which makes RMB attractive.

            Since 2009 RMB has been performing some of international currency functions that are given below........................

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