International Journal of All Research Education and Scientific Methods (IJARESM),

ISSN: 2455-6211, Volume 11, Issue 10, October-2023, Available online at: www.ijaresm.com

Internationalization of Local Currency & De-

dollarization: Empirical Insights from China and
Recommendations for India
Sashanka Sekhar Sahoo1, Shanehil Borah2

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ABSTRACT

This article examines the process of internationalizing local currencies, with a specific focus on the Chinese
Renminbi (RMB) and the Indian Rupee (INR), as well as their endeavours to decrease reliance on the United
States dollar. In the context of China, the primary emphasis lies on the measures implemented by the People's
Bank of China, including the establishment of Bilateral Currency Swap (BCS) agreements and offshore clearing
institutions. These initiatives facilitate the conduct of bilateral commodities trade and local currency
transactions. India's strategy encompasses the establishment of bilateral currency exchange agreements and the
proposal of measures to enhance the internationalization of the Indian Rupee (INR). These measures include the
utilization of bilateral swap lines and the expansion of payment infrastructure. Both nations seek to enhance
economic stability, promote international trade, and augment their worldwide geopolitical power through the
implementation of these measures.

INTRODUCTION

The process through which a national currency becomes extensively used as a means of trade around the world is
known as the "internationalization of currency." In general, this process is characterized by: a) the ability to use that
currency as payment for international transactions; b) the ability for residents and non-residents to hold financial assets
and liabilities denominated in that currency; and c) the ability for non-residents to hold tradable balances of that
currency outside of the issuing nation's borders.

Impetus for Renminbi Internationalization

The Great Financial Crisis of 2008 which led to a sharp reduction in Chinese exports, brought to front two vital
problems. One of these was the challenging reality that Chinese manufacturing confronted on a global scale. The
currency volatility accelerated the inherent risk in the international commerce, investment, and exchange mechanisms
where prices were set by more powerful Western currencies, primarily the US Dollar. This had a serious effect on
China's internal economy. Two, the increase in their foreign debt forced the Chinese policymakers to answer difficult
problems. Before the GCF, US Treasuries were considered a safe destination for Chinese foreign exchange reserves.
After 2008, however, Chinese policymakers faced increasing pressure to keep their foreign reserves away from U.S.
Treasury bonds. This was because a higher amount of Treasury bonds would trigger a devaluation of the US dollar
against a basket of currencies (if China continued to buy the bonds) or would trigger a rapid depreciation of the dollar
(in the event of a reversal of its investment policy in US Treasuries). resulting in an immediate loss of capital.
Consequently, the prevailing international situation was described as hostile to the Chinese economy, and overcoming
the dollar trap was seen as an urgent priority.

As a result, following the Great Financial Crisis (GCF) of 2008, the Chinese Renminbi underwent a slow process of
internationalization. The People's Bank of China (PBC) has implemented several policy initiatives, including bilateral
currency swap (BCS) agreements, offshore clearing banks, gradual opening of current accounts, and lowered regulatory
hurdles.

Bilateral Currency Swap Agreement: Policy Driving Internationalization China's financial markets remain
underdeveloped, but the PBOC is pressing for policy proposals based on its rising position and sheer scale in
international commerce and finance.

Since 2009, the PBOC has actively promoted the implementation of Bilateral Currency Swaps (BCS) agreements in
order to facilitate and increase the usage of the RMB in international commerce and financial operations. These BCS
agreements differ from earlier BCS agreements negotiated with Asian central banks, which were largely USD-RMB
swaps, in which the PRC's foreign reserves would act as an alternative credit line facility in the event of a balance of
payment or financial crisis.

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Figure 1 – Working mechanism of BCS agreements (source : Central Bank of Egypt)

Post-2009 swaps are fundamentally different in a way such that each one of them is between RMB and the local
currency of the partner country. The size of these swaps, despite being small, helps in making central banks of a broad
group of economies familiar and comfortable with RMB-denominated financial instruments and facilities.

To increase RMB-denominated activity, the PBOC inked a BCS agreement with the Bank of England (2013),
designating London as one of the major RMB trading centers.

These BCS agreements allow for bilateral commodity trade and local currency transactions. Signatory countries may
undertake trade and financial transactions in their currencies, so excluding the USD from the equation. Financial
instruments and transactions could be translated directly into the partner country's native currency without first being
converted into USD.

Figure 2 – China’s Export to Hong Kong (in thousand USD)

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Currency swaps enable a central bank to inject an equal amount of foreign currency into its domestic financial system.
These foreign currency reserves can subsequently be made available to commercial banks and other business
organizations to assist in settling import-related transactions involving participating countries. Meanwhile, exporters in
the partner nations usually receive payment in their local currency, which speeds up cash transfers and lowers
associated transactional costs.

Furthermore, BCS agreements provide a buffer against exchange rate fluctuation. Before the formal signing of these
agreements, a set exchange rate is determined, and this exchange rate remains constant during the length of the
arrangement. This helps local producers, buyers, and dealers to maintain long- term control over exchange rates and
keep trade activities financially secure. Over time, the impacts could be significant, particularly because lower
transaction costs and exchange rate volatility could enhance bilateral commerce.

However, the BCS agreement is more than just a financial mechanism for RMB internationalization. By joining the
network of BCS agreements with the PRC, the partner country not only ensures an alternate source of liquidity but also
strengthens its economic ties with the PRC. Furthermore, most of these BCS agreements are with Emerging Market
Economies (EME), with such countries expecting economic and geopolitical protection from the PRC, which may be
motivated by the fact that its currency (RMB) is utilized as reserves by such countries. As a result, BCS agreements
contribute to broadening the scope of the PRC's geopolitical aspirations beyond finance and trade operations to global
force projection.

The scope of the BCS agreement in the larger scheme of internationalization is not yet evident. The activation of the
RMB swap has been rare; in 2015, partner central banks used only 100 billion of the 3 trillion worth of swap. This is in
stark contrast to the US Fed Swap Lines, which were widely used during crisis periods. As a result, for the time being,
BCS has only been employed to alleviate the RMB liquidity shortage problem. As demonstrated by Bahaj and Reis
(2020) in their model, swap lines can minimize the perceived risk distribution of loan in a rising currency and
accelerate their use. As a result, the impact of swap lines extends beyond their actual utilization to a broader provision
of safety net.

Thus, the BCS agreement remains a tangible policy initiative that could help propel the RMB denominated bilateral
trade between the signatory countries. It also serves a broader objective of Chinese policymakers to help further
economic ties with Emerging Market Economies by providing them a liquidity buffer to ride out of a Balance of
Payments (BOP) crisis or financial crisis.

Offshore Clearing Banks: Providing infrastructure for Internationalization

One of the major prerequisites for a national currency to achieve international status is the presence of offshore markets
for that particular currency. US dollar ascendance to global status is possible due to the developed nature of offshore
USD markets, which allow non-residents to use it seamlessly. Over the years PBC has undertaken a series of policy
measures starting with setting up the first offshore market in Hong Kong in 2004. The development of offshore markets
for RMB denominated activity will help non-residents to trade with RMB. Since GCF, PBC has started the process to
develop offshore markets for RMB in Singapore and London.

For the purpose of our discussion, offshore markets are those markets that facilitate and specialize in transactions of
products that are denominated in currencies not issued by that offshore market. One of the major features of the
offshore market is its ability to separate currency risk from country risk. The currency risk combines with country risk
where the offshore market is located. Furthermore, offshore markets are located in countries which have a reputable
legal framework along with political and monetary stability.

Figure 4 – Share of Renminbi trade settlement rising Figure 5 – Renminbi invoicing for non-goods trade
(source: Bloomberg, Standard Chartered Research) (source: CEIC, Standard Chartered Research)

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The presence of an offshore market for a currency has both its advantages and disadvantages, all else equal, it
increases the overall liquidity of currency in the market. It separates country risk from currency risk. Moreover, it
provides a mechanism to bypass rules and regulations that might be there in the onshore market. The typical cost issue
is that a weakly regulated offshore market might lead to monetary and financial instability by amplifying market risk
and undermining governments' ability to conduct domestic policy and manage capital flows.

The PBC since 2003, has undertaken a conscious step towards establishing offshore clearing banks in 25 economies to
facilitate RMB payments. From 2016 onwards, PBC has granted permission to foreign banks like JP Morgan in the US
and MUFG Bank in Japan.

The establishment of offshore clearing banks is an important step in developing both infrastructural capacity and
regulatory robustness in cross-border RMB transactions. Due to the restrictions on capital accounts in Mainland China,
foreign banks are required to clear and settle their RMB transactions through China’s local correspondent bank; this
process is however time-consuming and costly in nature. By integrating offshore financial establishments, RMB could
be settled directly with the local clearing bank, operating in the same time zone, often using the same language and
legal framework. This simplifies the overall transactional process. The establishment of offshore clearing banks are
precursor to the development of offshore clearing markets by ensuring a steady accumulation of RMB liquidity in these
markets.

China has also brought into front a new cross-border payment system known as CIPS (Cross-Border Interbank Payment
System). This payment system has the potential to reduce the role of offshore clearing banks in the future. CIPS is open
to all foreign financial institutions regardless of jurisdictions. The major advantages of CIPS is that by participating in
CIPS scheme, onshore and offshore banks could gain direct access to China National Advanced Payment System
(CNAPS), which is the domestic clearing system run by the PBC.

(Source: Shanghai Clearing House (SHC) Standard Research

Figure 6 – CNH bond holdings from China investors via the southbound Bond connect program

CIPS adoption and RMB internationalization will be further accelerated by China’s increasing engagement with
Emerging Market Economies (EME) in the form of Belt and Road Initiative (BRI) projects. These projects involve
Chinese companies and will potentially use RMB denominated RMB. Also, CIPS has also adopted SWIFT identifier
codes and the ISO20022 messaging standard, this simplifies the cross-border transactional process and will most likely
contribute to its acceleration.

Thus, Chinese policymakers have undertaken a slew of measures to increase the liquidity of RMB in offshore markets;
it hopes to do so in two different ways. One, establishing offshore clearing banks that allows for direct transactions for
RMB without involving corresponding local Chinese banks, this is however a short-term measure. Two, PBC has built
its SWIFT-alternative known as CIPS, which is not bounded by jurisdiction and provides for wider access to both
offshore as well as onshore (or domestic) markets, in long term CIPS aims to replace the role played by offshore
clearing banks.

Bilateral Currency Swaps: New Policy Paradigm for RBI

INR internationalization has been a long process; India has previously attempted Rupee trade with Russia, Nepal,

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Bangladesh, Iran, and East European countries such as Hungary, Romania, Czechoslovakia, East Germany, and
Yugoslavia. The scope of such a Rupee Trade pact, however, was limited. The complementarity of items sold between
India and the partner nation was the basis for trade agreements with Soviet Bloc countries. The success of such accords,
however, might be attributed to central planning and state monopoly of foreign commerce in the USSR and East
European countries prior to 1991, as well as India's regulated trade regime via quotas, licenses, and regulations. As a
result, there was a significant absence of private sector participation in the rupee trade. As a result, given the private
sector's involvement in cross-border trade and the expanding globalization, extending this type of rupee trade
agreement is not appropriate. Therefore, a more flexible mechanism would be required to increase liquidity of INR in
foreign markets and to promote its usage in international invoicing.

The RBI recently recommended several measures to speed up INR internationalization in its Inter- departmental Group
(IDG) report. To bolster liquidity arrangements in times of financial crisis, India has entered into several bilateral and
international currency exchange agreements. In 2002, the SAARC Currency Swap framework was created to supply
short-term forex liquidity or balance of payments (BOP) stress. Its goal is to improve regional financial and economic
cooperation. The Reserve Bank of India agreed to offer USD 2 billion (withdrawal in USD, Euro, and INR) within this
framework. Special allowances are built within the framework to encourage INR withdrawals. All SAARC countries
are eligible for the currency swap arrangement if they sign the bilateral swap agreement.

Leveraging Bilateral Swap Lines will be crucial for INR internationalization. Certain approaches to provisioning INR
liquidity could be taken, and negotiated lines of INR liquidity from Indian commercial banks to foreign entities could
be established for an appropriate risk-based period (beyond intra-day). The RBI should simplify provisioning/risk
weighting to encourage domestic commercial banks to negotiate lending limits. Banks can also get INR liquidity from
their central banks and finance them through bilateral/multilateral swaps. International central banks may explore an
INR repo facility like LAF.

Moving forward, INR liquidity to offshore Indian banking institutions would be provided by their onshore parents,
which will allow RBI to keep its balance sheet protected to an extent and only act as a lender of last resort, whenever
required.

RBI could formulate a scheme that is similar to the LAF facility. Under this scheme, the other central banks and
sovereign-backed entities which have investment in government securities (G-secs) may be allowed a fixed repo rate
and fixed reverse repo rate for an extended period of time. This will also add an alternative avenue for deployment of
surplus funds. Central banks and sovereign entities which will use the facility of INR liquidity from the RBI, could act
as clearing agents for institutes within their jurisdiction.

Providing payment infrastructure for offshore adoption

Ensuring the provision of essential payment and settlement infrastructure is crucial in facilitating smooth cross-border
commerce transactions. Hence, the Reserve Bank of India (RBI) has the potential to incorporate Real Time Gross
Settlement (RTGS) as a means to facilitate cross-border transactions.

The recently introduced system, referred to as International Real-Time Gross Settlement (IRTGS), allows banks located
in offshore territories the opportunity to obtain IRTGS membership. This membership enables them to engage in
transactions using international currency and/or the Indian Rupee (INR) with other partner banks inside the IRGTS
mechanism.

The implementation of the IRGTS system can be achieved by the establishment of a network of nodal and sub-member
banks operating within a specific jurisdiction. To provide an illustration, it is proposed that a bank in each respective
country shall function as the nodal bank, while other financial institutions inside that country shall serve as sub-
members.

The subsidiary banks will utilize the secure communication channels in order to transmit SFMS messages to the nodal
banks. After conducting the required due diligence, the nodal bank would subsequently transmit the message to
INFINET (Indian Financial Network) via an international hub. Each nodal bank will maintain a settlement account with
the Reserve Bank of India (RBI) for transactions involving internationally accepted currency or Indian Rupees (INR).
For domestic transactions involving local currencies, each sub-member will hold settlement accounts with the
respective nodal banks. These sub-members will be required to deposit their pledged currency with the nodal banks.

These systems and mechanisms could be leveraged to integrate with similar systems in other jurisdictions to facilitate
cross-border payments. RBI could also expand SFMS mechanism within the proposed IRGTS mechanism to provide
domestic financial institutes a platform to access offshore jurisdictions and markets.

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(Source: RBI IDG report on INR international transaction)

Figure 7: Transactional Flow by IRGTS system

These systems and mechanisms could be leveraged to integrate with similar systems in other jurisdictions to facilitate
cross-border payments. RBI could also expand SFMS mechanism within the proposed IRGTS mechanism to provide
domestic financial institutes a platform to access offshore jurisdictions and markets.

India possesses one of the most extensive diasporas globally, resulting in a significant influx of remittances into the
Indian financial system. The transactions frequently include the use of United States dollars (USD), which results in
extended processing time and elevated expenses for both the sender and the recipient. The integration of this
mechanism could be facilitated through the implementation of a model project, as demonstrated by the collaborative
efforts between the Reserve Bank of India and the Monetary Authority of Singapore (MAS). The initiative aims to
establish a connection between their expeditious payment systems, namely UPI and PayNow. This integration will
facilitate instantaneous fund transfers (remittances) for users of both systems. The establishment of connections
between real-time payment systems has several advantages, such as enhancing the rate of settlement, facilitating ease
and speed of transactions, and reducing transaction costs. The utilization of Virtual Payment Address (VPA) facilitates
the transaction process by eliminating the requirement for onboarding onto alternative payment systems. Furthermore,
these payment systems are characterized by real-time processing capabilities, hence enhancing the convenience and
efficiency of conducting transactions. This measure would enhance transparency in the transactional process by
providing upfront visibility of the relevant foreign currency rate and charges prior to conducting transactions.
Moreover, the real-time nature of these transactions contributes to a decrease in the associated costs of the transactional
process, leading to a reduction in markup.

CONCLUSIONS

The internationalization of local currencies and process of de-dollarisation are complex and multifaceted endeavors
with far-reaching implications for the global financial and economic landscape. This paper has provided insights into
the process via which a local currency could be propelled to the status of international currency. China and India being
largest fasting growing economies have undertaken a number of policy and reform initiative aimed at internationalizing
the RMB and INR respectively.

China’s journey towards RMB internationalization began as a response to 2008 GCF, which exposed the danger
embedded within the global financial markets this included the fact that international markets were over-reliant on USD
for cross-border transactions. The PBC henceforth had undertaken a number of measures to reduce its dependance on
USD while also promoting RMB as an international currency. These measures included Bilateral Currency Swaps
which were based on RMB-Local Currency mechanism (as opposed to USD credit lines initiated by the US Fed in the
aftermath of GCF). These BCS agreements helped in providing a liquidity buffer needed for EME in case of financial
or balance of payments crisis. The PBC has also pushed for developing offshore clearing markets for RMB trading,
which will be relatively less regulated than the domestic markets in Mainland China. Offshore markets also help in
separating country risk from currency risk. It has also tried to integrate its SWIFT counterpart i.e., CIPS into the cross-
border trade settlements. Integrating such a system into the global financial markets will reduce transaction costs in the
long term and help in the internationalization process of RMB. However, there are skeptics that believe that RMB
internationalization couldn’t be taken place without fully developing

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India has been working on INR internationalization since the early 1950s through the Rupee-Trade Agreement, but
such processes are very hard to reproduce in a worldwide market. RBI has entered into bilateral swaps agreements with
partner countries to use INR for cross-border payments. It wants to integrate its payment systems like RGTS and UPI
with Singapore, Nepal, and others to increase INR remittances. RBI has been hesitant to implement such measures to
better oversee fiscal and monetary policy.

In conclusion, China and India both acknowledge the importance of internationalizing their currency, but their
economic and political circumstances dictate their approaches. Both countries want to internationalize their currency to
boost their economic stability, trade, and geopolitical might. Thus, as these two economies continue their
internationalization travels, their experiences might inspire other states seeking global economic and political
dominance.

REFERENCES

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