ECB bulletin examines 'virtuous circle' in Chinese reforms

The reforms needed to cure China's internal imbalances and those necessary to promote the renminbi as a reserve currency could be "mutually reinforcing", according to an article in the latest European Central Bank (ECB) monthly bulletin.

The January bulletin, released today, includes an article exploring China's economic performance and ongoing reform programme. The article calls for "ambitious structural reforms" to boost private consumption and describes the Chinese government's plans as "promising in this respect".

China's role in the global economy is changing. The country's current account surplus shrunk from around 10% in 2007 to 2% in 2013, which represents "substantial improvement" in the country's external imbalances.

Internal imbalances have, however, continued to grow. Domestic demand is increasingly skewed towards investment. Indeed, the share of fixed investment in real GDP rose to 46.1% in 2012.

The government has committed to embracing market forces throughout the economy. It plans to reduce price regulations across a host of services, boost labour mobility, increase bank competition and, importantly, open Chinese markets to more foreign investment.

The hope is these reforms - among others - will help put the economy on a more sustainable growth path based on private consumption. The article says the authorities' success will depend on the way in which, and the speed at which, they implement these reforms.

"Given that the decisions taken are broad policy intentions, rather than fully developed plans, it is difficult to assess their economic impact," the article says, but "the systemic nature of the proposed reforms signals a desire to tackle the underlying causes of economic imbalances".

The reforms aimed at reducing China's internal imbalances could also serve to make the renminbi more attractive as an investment currency, in so far as they promote domestic stability and deeper financial markets.

"As some of the reforms that are vital for the internationalisation of the renminbi coincide with those needed to rebalance China's growth, this may result in a virtuous circle," the article says.

The renminbi is increasingly being used in the settlement of trade and financial transactions with China. The ECB established a €45 billion ($61 billion) swap line with the People's Bank of China in October to provide a 'safety net' for the growing levels of bilateral trade and investment flows between the eurozone and China.

Nonetheless the renminbi has not yet achieved the status of an international reserve currency because, the article points out, China's capital account "remains largely closed and subject to tight regulation". As a result, investors can be unwilling to issue financial instruments in the currency.

"The role of the renminbi in the future international monetary system is difficult to predict," the article says. "As a result of strong fundamentals and helped by supporting policies, it is believed that the renminbi will become an important international currency."