China’s importance to the global economy makes it difficult to believe the role of the yuan in foreign exchange will not continue to expand. Will that dominance advance sufficiently to make the Chinese renminbi one of the world’s reserve currencies? A new study from the Brookings Institution suggests that in the long run, the ascendance of the yuan to reserve-currency standing is likely. It notes that of the six largest economies in the world, China is the only one whose currency does not have reserve status. But the road to getting there will be long and tortuous, the study warns, and there will be plenty of potholes.
Getting there will require overcoming two main challenges, according to Eswar Prasad and Lei Ye, who authored the report:
Sequencing of capital account opening with other policies, such as exchange rate flexibility and financial market development, to improve the cost/benefit trade-off.
Financial market development – strengthening the banking system; developing deep and liquid government and corporate bond markets, as well as foreign exchange spot and derivative markets.
That’s another way of saying that China’s exchange rate policy, which many in the United States
argue has been to keep the yuan artificially low in order to boost exports, is actively standing in the way of a bigger role for the yuan in international trade.