During the 2008 financial crisis, Asia experienced exchange rate volatility and liquidity shortages of the key currency—the US dollar—that severely affected trade within the Asia-Pacific Economic Cooperation (APEC) region. The dollar is crucial to maintaining financial market stability at an appropriate liquidity level. While the dollar is expected to remain the key currency in the foreseeable future, the crisis has led to a rethinking of the global economy’s over-reliance on the dollar and its capital and financial markets, and the need to enhance the role of emerging currencies and their markets.
While it will take time for emerging market currencies to become significant reserve currencies, their growing importance in the settlement of cross-border trade and investment can no longer be ignored. This is particularly true for the Asian region, where trade and investment flows are and will remain for a long time the major drivers of economic development. In addition to the cost savings and alleviation of Herstatt risk1 resulting from direct settlement in these currencies, countries in the region stand to gain from the consequent reduction in their dependence on the US dollar and the euro. This will enable them to avoid a repetition of their recent experience, when the drying up of trade finance in the wake of liquidity shortages of key currencies produced significant economic disruptions during the recent global financial crisis.
Internationalizing emerging market currencies
As one of Japan’s representatives in the APEC Business Advisory Council (ABAC), I proposed that ABAC develop and submit a recommendation to APEC Finance Ministers and leaders to facilitate the internationalization of emerging economies’ currencies. The People’s Republic of China (PRC), Japan, and the Russian Federation collaborated on a joint recommendation to the leaders and ministers that was supported by all ABAC members before the Vladivostok APEC leaders’ meeting in September 2012. The PRC and the Russian Federation have national policies to promote their own currencies’ internationalization in line with domestic market liberalization based on their growing economic presence in the region. I believe that Japan’s interests are complementary with these efforts, as the yen’s internationalization will move forward in line with the internationalization of the renminbi and the ruble. Direct settlement of the yen against those currencies will also help to internationalize the yen. The recommendation from the PRC, Japan, and the Russian Federation would promote the use of emerging market currencies in the settlement of trade, investment, and cross border capital market transactions in APEC markets. Emerging market currencies that have become internationalized may become anchors in times of turmoil and crisis.
Background to the recommendation
Before this proposal was submitted to APEC, the leaders of the PRC and Japan concluded an agreement to promote cooperation for the mutual development of their financial markets in December 2011. This agreement included cooperation to promote cross-border direct settlement of trade and investment from yen to renminbi and vice versa. The PRC and Russia had agreed to promote direct settlement in 2010. The proposal was to extend these cooperative arrangements to the regional level and to seek practical facilitation measures in the APEC arena.
How can currency internationalization be promoted?
Facilitation measures need to be pursued if the policy goal of internationalization is to be met. The Institute for International Monetary Affairs hosted a forum in October 2012 on the subject of the facilitation of settlement from yen to renminbi. Liquidity was one discussion point. Ample liquidity is needed for daily use and as a backstop in a crisis. Government-to-government or central-bank-to-central-bank currency swap agreements will be needed to supply liquidity for emerging market currencies. The swap proceeds should be provided to the market. In due course there may be commercial-bank-to-commercial-bank or commercial-bank-to-central-bank swap agreements with collateralized government bonds for credit enhancement.
The cross-border emerging currency capital and banking markets will also be needed to promote lending and bond issuance through relaxed capital controls. Accumulated deposits denominated in emerging market currencies make it possible for lenders and borrowers to tap the market. For example, Hong Kong, China is a developed market for current and capital account transactions of renminbi backed by deposits.
Another facility that needs to be explored is a well-functioning clearing system for emerging currencies in the overseas market. The clearing center’s role can be played by banks with correspondent accounts in the emerging market’s currency.
These are crucial prerequisites to promoting markets for emerging currency use.
Internationalization of emerging market currencies, especially the renminbi and the ruble (given the weight and potential of the Chinese and Russian economies), is gathering momentum with their major trade and investment partners in neighboring countries and the region. Adding these currencies to the US dollar as key international currencies would make the international currency system more robust.
1 Herstatt risk is the risk that a party to a trade fails to make payment even though it has been paid by its counterparty. It is named after the German bank Herstatt whose license was withdrawn by regulators on 26 June 1974 due to its inability to cover its liabilities. This forced the bank into liquidation, which ceased operating. Because of time zone differences this meant that Herstatt was unable to pay some New York banks for foreign exchange it had received before it ceased operating.
It would be an amazing and welcome development if the ruble were to become an international currency.