Shahid Javed Burki
Having worked as the Director of World Bank’s China Operations for seven and a half years, I developed an appreciation of how the Chinese leadership takes major decisions. I was appointed in May 1987 to head the newly-created China Department and in that position for almost eight years, moving end of December 1994 to head the World Bank’s Latin America and Caribbean region. The Chinese practice is to move with great caution when they wish to change the direction in which they have been going.Once a consensus had developed among the ranks of the senior leadership, they experiment by launching pilot projects and only when they are satisfied that the new approach would work, they adopt it nationwide.
When I took charge of the China Department, the world governed by Communism was entering a period of chaos that eventually led the demise of the ideology in eastern Europe and in 1991, the collapse of the Soviet Union. The former Communist countries adopted what came to be called the “big bang” approach to making the transition to market-based economies. In one go, they abandoned the state’s control over the economy. Government owned assets were handed over to political favorites.
Hundreds of people overnight became “oligarchs.” The Chinese did not have the appetite for moving that way. After all, Deng Xiaoping, who begun to open the Chinese economy to the outside world in 1980, had said famously that it is not wise to cross a water stream in one leap but to do so by feeling the stones one step at a time. I entered this debate in the halls of the World Bank where there were a number of proponents of the big bang approach especially those who had worked or were working on Russia.
With that as the background I will discuss the “internationalization of the renmenbi,” the Chinese currency. This was the subject of a roundtable discussion in Lahore sponsored by the University of Lahore and Renmin University of China. I was a panelist and made the argument that China had moved cautiously to the point where the renmenbi had been given the status of an international reserve currency and is now included in the basket the International Monetary Fund uses to value its own currency, the Special Drawing Rights, SDRs, in which it conducts its foreign operations. China got to that point in several steps. Some of these it took with the help of the World Bank by following the institution’s advice.
The reshaping of the Chinese currency has gone through several phases, each one well thought through. In thinking about the internationalization of the Chines currency, my mind goes back 55 years, to 1965. The summer of that year was the first time I visited China. That I did in the company of a three-member group from the Government of Pakistan. We were invited to observe and then write about the system of Chinese Communes which was receiving a lot of negative western attention. The Chinese authorities were expecting a more sympathetic treatment but that did not turn out to be the case. But that is another story for some other time.
When we arrived at the Beijing International Airport which then was like any other airport in the developing world, we were asked to surrender at the immigration counter all the foreign money in our possession. Each one of us was given $5,000 by the government in Pakistan to cover the six-week period we were to spend in the country. We did and in return we received a sheet of paper titled the “Foreign Exchange Certificate.” The official at the counter noted the amount he had received from us and said that we will use it in all the transactions we will be making during our stay. The foreigners could stay in one of the two hotels open to them in Beijing and shop in a couple of stores that operated under the name of Friendship Stores. The amount we spent was noted on the FEC and subtracted from the total. At the end of the stay we surrendered the FEC at the airport counter and received in dollars the amount that remained.
My second encounter with the FEC was in 1987 when I visited China for the World Bank. In 1980, the Chinese decided to print the FECs on currency paper. They were now available at the financial institutions that transacted in foreign currencies at the published rate of exchange. The FEC had a different rate of exchange than the yuan, the currency used by the locals. There was now much wider use of the FECs without any constraints. The next step came in 1994, when the FECs were merged into the local currency, the renmenbi. China now had one national currency valued at one rate of exchange with foreign currencies. The exchange rate was set by the government.
The next big move in finance was on the fiscal side; a move in which we in the World Bank got heavily involved. In our continuing dialogue with the authorities, we emphasized that the monetary and fiscal sides of the financial system had to move simultaneously. The monetary system should not move way ahead of the fiscal system. The Chinese at that time were operating a highly decentralized system in which the collection of taxes was done by the local governments. Surrender of the collected amounts was negotiated by Beijing with individual provinces and municipalities. This was a political process; the local governments who had powerful presence in Beijing could retain a higher share of the amounts collected than the politically weak jurisdictions. Our advice that the system should be reversed with the taxes collected by the central government and the amounts handed over to the provinces determined by a formula that was applied in a nondiscriminatory way. This change meant significant change in the structure of the legal system that governed relations between different departments of the government. The World Bank was asked to help with the process of making the transition.
Our next big involvement with the reform of the financial sector was to transform the People’s Bank of China, PBC, into a true central bank. This happened in 1995. Until then the PBC had functioned as a commercial bank, taking in deposits and dispersing them according to the wishes of the authorities in power. It was established in 1948 with the consolidation of three banks. Following the opening up of China and the adoption of the economic reform agenda, the PBC’s commercial banking was handed over to four independent but state-owned banks: the Industrial and Commercial Bank of China (ICBC), the Bank of China (BOC), the Agricultural Bank of China (ABC) and the China Construction Bank (CCB). In 1983, the Chinese authorities issued an order saying that the PBC would function as the central bank of China.
In the spring of 1993, I was called by Vice Premier Zhu Rongji to help his government
turn the PBC into a well-functioning central bank. I assembled a group of central bankers including the head of the Federal Reserve Bank in New York, the Governors of the Central Banks of Chile, and Jordan. We traveled to Beijing after preparing a document for the Vice Premier which we discussed with him in a meeting that lasted for several hours. Most of the suggestions we made were adopted by the government.
In moving the renmenbi into the international arena, China kept its approach of feeling the stones in crossing a stream. It had followed the strategy laid down by the World Bank in its 1993 report of the “miracleeconomies” of East Asia. This involved the use of cheap labor available in abundance to produce low-cost manufactures for the markets in the West, in particular in the United States. China exported great quantities of cheap manufactures to the United States buying in return farm products, aircraft and machinery. The trade account was heavily in China’s favor with the result it accumulated large amounts of American dollars which it kept in the United States. Over time China became the United States’ largest creditor, with $1.18 trillion in U.S. Treasuries. This amounts to 7.2 percent of the U.S. total debt-load. However, China felt that by relying on a few large markets for absorbing its exports, it was exposing itself to possible pressures which it would not want to endure. Geographical diversity meant using its own currency to pay for trade. The best way of using the renmenbi for this purpose was to enter into “swap arrangements” with some of the central banks around the world. Under these arrangements deposited renmenbi with the central banks could be used to pay for trade thus taking the American dollar out of the equation. This was a step towards the internationalization of the renmenbi. According to the Society of Worldwide Interbank Financial Telecommunications, popularly known as SWIFT, the path of renmenbi internationalization could be divided into three phases: first as usage for trade finance, then for investment, and in longer term, as reserve currency. China is making steady progress towards implementing the third phase. On November 30, 2015, the IMF voted to designate the renmenbi as one of the several world currencies included in the basket of determining the value of the SDR. It was the first emerging market currency to be included in the basket. Its share in the basket was placed at 10.92 percent well above that of Japan (8.33 percent) and Britain (8.09 percent). The United States dollar remained in the lead at 41.73 percent followed by the Euro at 30.93 percent.
China is now well on the way to make its currency fully convertible and available for all types of transactions. Pakistan like many other countries allows individuals and private enterprises to maintain dollar accounts in the banking system. The day is not far when renmenbi accounts would also be permitted. This would ease the movement of goods, services and people across the border.
Shahid Javed Burki is Chairman and Member Board of Governors of the Shahid Javed Burki Institute of Public Policy at NetSol (BIPP).