China and Pakistan have often used slogans to highlight the importance of their relationship. Talk of a bond “higher than the Himalayas, deeper than the deepest ocean, and sweeter than honey” runs deep. Given the historical strength of Sino-Pakistani relations, Pakistan emerged as a natural location for China to pilot its ambitious Belt and Road Initiative (BRI). Pakistan, faced with persistent security issues, infrastructure shortages, and governance problems, struggled to attract foreign investment from the West and embraced Chinese largesse with open arms. It seemed like a good location for China to highlight the BRI and, at the same time, to take tentative steps toward the internationalization of China’s currency, the renminbi (RMB) – two important policy goals.
Out of this collective serendipity emerged the China-Pakistan Economic Corridor (CPEC), launched in 2015 to address Pakistan’s persistent power sector and infrastructure woes. CPEC’s long-term plan ultimately envisages connecting western China with the Arabian Sea via Balochistan. As the most developed section of the BRI to date, CPEC is particularly important for China as it has the potential to demonstrate the promise — or peril — of the BRI to other countries. In Pakistan, CPEC has repeatedly been heralded as a “game-changer” that will “take Pakistan to new heights [of prosperity].”
Not all has gone according to plan. Pakistan’s messy local political economy, IMF-imposed austerity, concerns over the rising current account deficit, and now COVID-19 have cast a pall over CPEC’s expansion. Furthermore, despite China’s vocal push to internationalize the RMB, until now, all CPEC projects were funded in U.S. dollars. Recently, however, there has been a renewed push to look for alternatives to dollar-based project financing, and expansion of the RMB in Sino-Pakistani cross-border trade. CPEC will likely have an impact on the RMB’s internationalization.
Pakistan’s Embrace of the RMB
CPEC is at the fore of efforts to promote the RMB’s use as an international currency. After some fits and starts, the renminbi seems poised to replace the dollar in several key CPEC projects. Last fall, the two countries announced that renminbi would be used to finance all future energy and transport projects placed under the CPEC umbrella. A hydropower plant in Kashmir and the ML-1 railway line project connecting Peshawar to Karachi are to be the first projects financed under this arrangement.
A key impetus for jettisoning the greenback came from the Pakistani side, not China. Pakistan first proposed replacing the dollar with the RMB for CPEC financing and has pushed China to double the current RMB Currency Swap Agreement (CSA) to 40 billion RMB. Domestic economic realities in Pakistan, and not external pressure from China, impel the RMB’s expansion: Big CPEC infrastructure projects and payouts to Chinese firms contribute to persistent current-account deficits, rising debt, and reduced foreign reserves.
It appears the Chinese side might be finally catching on. China’s consul general in Karachi, Li Bijian, recently urged Pakistan to “seize opportunities” and “take full advantage” of RMB financing to reduce the pressure of the country’s dwindling dollar reserves and mitigate adverse effects of quantitative easing.
The Staying Power of the USD
Yet headwinds remain. Even with official backing, private sector enthusiasm remains low. Chinese firms have proven reluctant to embrace RMB financing, a conspicuous reminder of the dollar’s staying power. For the same reasons that Pakistan seeks to protect its dollar reserves by expanding RMB-denominated funding, Chinese firms prefer to be paid in dollars.
At the national level, RMB internationalization poses other problems. Further internationalization would undermine China’s strict capital controls and managed exchange rate, and ultimately complicate its central bank’s ability to pursue an independent monetary policy. This conundrum has forced China to take an unorthodox route toward internationalization, one based on trade. BRI thus gives China its best shot to globalize the RMB.
For China, the geopolitical benefits of RMB internationalization are clear: the dollar’s primacy as a global reserve currency allows Washington to leverage international systems and banks in the narrow pursuit of its own foreign policy goals. Every dollar-based transaction is ipso facto subject to U.S. scrutiny, and few banks are willing to risk being cut off from the dollar-based financial system to conduct trade with Iran, Russia, China. or other American adversaries.
The dollar’s primacy is also its Achilles’ heel. The specter of American sanctions has propelled China’s RMB internationalization drive to new heights in places like Russia and Iran, where the new Sino-Iran deal will likely be funded via RMB.
Prospects for RMB internationalization in other BRI countries remain unclear. China’s RMB-denominated trade with BRI countries grew 32 percent in 2019, notes this year’s People’s Bank RMB internationalization report. Tajikistan, Kyrgyzstan, and Uzbekistan are key BRI partners who face many of the same economic challenges as Pakistan. On paper, they are good candidates for conducting bilateral trade in RMB, but their small economies limit the possibilities for RMB expansion. Russia has emerged as one of the most enthusiastic backers of renminbi internationalization, purchasing one-quarter of global yuan reserves last year. However, even Russia serves as a cautionary tale of the challenges facing the RMB: as both China and Russia push to de-dollarize their bilateral trade, the euro — not the ruble or the RMB — has primarily taken the dollar’s place.
Whether China can successfully push RMB internationalization to other BRI countries remains to be seen. Symbolic steps have already been taken, such as the expansion of Currency Swap Agreements (CSAs) with many countries. In particular, Central Asia’s growing dependence on Chinese trade and the RMB’s relatively fixed exchange rate makes it a safe bet for central banks seeking to lessen reliance on the unstable ruble. However, the same trade deficits that impel the RMB’s internationalization also constrain its growth: There is only so much trade that can be conducted with China.
China’s goal is to achieve currency multipolarity, not just overthrow dollar unipolarity. The country touts its small victories on currency swaps and cross-border trade agreements. The real test of the RMB’s reach will be if other countries start to adopt it in their own bilateral trade. That is unlikely — the demise of the dollar does not necessitate the rise of the renminbi. The BRI, including the proposed CPEC project financing, will brighten prospects for RMB internationalization, but market realities and China’s own economic rules ensure that progress will be slow.
Dr. Muhammad Tayyab Safdar is a post-doctoral researcher at the Department of Politics and East Asia Center, University of Virginia. Joshua Zabin is a research assistant at the Belt & Road Initiative Project, East Asia Center, University of Virginia.