AbstractThe rapid expansion of China's economy and trade has been associated with explosive growth in its financial markets and institutions. This has fuelled a debate into the possibility of its currency potentially developing into a primary reserve currency. The debate around this topic began in 2005, when the Renminbi (RMB) became the world's fifth-most used payment currency. By July 2009 the Chinese government launched a pilot programme signalling the desire of pushing towards RMB internationalisation. After a series of reforms, the RMB was successfully added to the IMF's Special Drawing Rights portfolio in 2016, with a weight of 10.02 percent. This has further strengthened the currency's global acceptance. In recent years, the debate on how far the RMB reserve currency status will develop has been further fuelled by the perception of the U.S. exploiting USD financial hegemony for political purposes. Many commentators see that the time is right for a new challenger currency to emerge.
The principal research question of this thesis to identify the primary factors that determine reserve currency status and apply a Panel data to model and examine the extent to which the RMB will develop into an international reserve currency over the next two decades. A model is developed to forecast currency shares of the world's dominant reserve currencies over the next two decades, with the focus of this analysis being the RMB. The question asked is: will the world currency system remain unipolar and dominated by the USD, or will the rise of the RMB with the EUR to push it towards a multipolar system? There is a secondary research question in the thesis. Specifically, it aims to identify the extent to which the RMB is likely to play a role in the ‘for investment’ tranche of international reserve currencies by using GARCH.
Much of the academic literature in the area of reserve currencies is based on historical analysis of monetary systems and events with usually only limited levels of statistical analysis. In this thesis, a different approach is taken. The methodology used to examine the research questions are based on cliometrics which combines the rigour of fundamental historical analysis and economic theories with quantitative analysis. The main novel contributions and the findings of this thesis are based on these applied statistical analyses.
A Panel data econometric model is developed to identify the principal factors which determine reserve currency shares. The results identified economic and financial variables that could be represented by a country’s share of world GDP appearing to be the most important. The Panel model is used to forecast future reserve currency usages of the RMB until 2040. This is the main contribution from this thesis. RMB reserve currency share was 12.65 percent in 2018. A number of different future economic growth scenarios are tested using a 'what-if' analysis. For example, based on a high China GDP growth assumption, the model predicts that this will increase to 14.56 percent in 2020, 19.67 percent in 2025 and 21.48 percent in 2030. Also, if all the variables (beside GDP) are fixed in 2030, then from the high GDP growth assumption, the RMB will increase to 28.21 percent in 2040. From the analysis undertaken, the thesis concludes that the USD will continue to dominate the reserve currency market with a share above 64 percent. The international reserve system is therefore seen as remaining unipolar, however, with the RMB and the EUR both having a significant market share. The expectation is therefore not so much multipolar reserve currency system, but a USD dominated unipolar market with a competitive fringe. With the fringe consisting of the RMB, EUR and JPY.
The second novel contribution of the thesis is to apply a dynamic mean-variance analysis to calculate the optimal reserve currency allocations of central bank investment tranche of reserve currencies. This examines whether adding the RMB to central banks’ investment tranche reserve assets would bring them additional benefits. This question is considered from the perspective of three different income country-types; namely: a developing country (Philippines), a middle-income developed country (Russia) and a well-developed country (Canada). Using an unconstrained model, the average for the three countries showed RMB usage is 22 percent, and USD is 20 percent with respect to this investment tranche. A further set of constrained models were run, with a risk-related constraint based on a country's external debt ratio in the specific currency. Given that much of this debt is USD based, this considerably increases the USD share. For example, using a 75 percent external debt constraint, the RMB share falls to an average of 13 percent and the USD increases to 53 percent. The reality is that there are many constrains on a central banks’ currency choice, and these may result in the actual RMB share being considerably lower than the model suggested.
As an overall conclusion, the thesis suggests that the RMB has considerable potential as a reserve currency, and its usage should significantly increase in the next two decades. Also, the research indicates that for the next two decade at least, the reserve currency system will remain unipolar. The USD is expected to maintain its dominant position as the leading reserve currency with a 64 percent share. However, even by 2030, the RMB market share is expected to increase significantly. And by 2040, it may come a little closer to challenging the dominant position of the USD. To achieve this, China still needs to focus on its market reforms, in particular liberalising its capital account and providing a more fully developed financial system.
A further caveat has to be added to this analysis; the impact of the COVID-19 virus on world financial markets is as of yet unknown. This is likely to have a massive effect on the world financial system and may produce a potential Minsky moment that changes the architecture of the financial system and how the reserve currency market operates. Along with the USD hegemony, these might increase the attractiveness for other currencies as the reserve currency.
|Date of Award
|Timothy Rodgers (Supervisor), Hui Pan (Supervisor), Jacek Niklewski (Supervisor) & Wei Song (Supervisor)