Debt mismatch calls for renminbi convertibility

Subject

China's foreign currency debt.

Significance

Recent weak economic data raised the prospect of renminbi depreciation as policymakers seek to mitigate the effects of weak exports on the domestic economy. Devaluation would reduce the value of China's foreign liabilities in dollar terms, but would do little to ameliorate the longstanding mismatch between China's onshore and offshore currency liabilities. The mismatch is centred on China's holdings of large foreign currency denominated assets and the slow pace of capital account liberalisation. While the release of positive foreign direct investment (FDI) data and a large cut in the commercial banks' reserve requirement have diminished the prospect of devaluation in the short term, the mismatch in China's net investment position poses a risk to the domestic economy.

Impacts

• A devaluation of the renminbi would not improve China's net investment position in the long term.
• ODI and the expansion of the currently small pool of renminbi deposits held abroad reduce the risks from currency mismatch.
• Full internationalisation of the renminbi offers the most sustainable way of rebalancing China's net investment position in the long term.