An Empirical Evaluation of RMB Internationalization as Reserve and Investment Currency

When the global financial crisis of 2008 revealed the inherent defects of the existing dollar-centered international monetary system, the People’s Republic of China (PRC) government has started its efforts to promote the use of its currency, RMB, internationally. In this paper, we analyze the potential of the RMB to join a club of international currencies. For the sake of analytical convenience, this paper focuses on two different functions of an international currency; one is the investment currency demanded by the private sector and the other is the reserve currency demanded by the public sector for the purpose of official foreign exchange reserves. To predict the possibility of RMB internationalization, we conduct an analysis on the effects of economic and financial determinants, such as GDP, trade volumes, price and exchange rate stability, and development of financial market, on the internationalization of currency, using panel data. The empirical results show that it is now unrealistic for the RMB to shortly become a strong candidate for reserve currency. However, our empirical results support possibility that the RMB could become investment currency through the private sector’s demand for RMB-denominated bonds. These empirical findings strongly suggest that despite the numerous limitations the RMB has a potential to join a rank of international currencies with the U.S. dollar and euro, ultimately forming a tri-polar global currency system in the future.