Market turmoil and the future of Chinese institution building

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As the financial crisis in China unfolds, analysts are scrambling to grasp the implications for the global economy. As Martin Wolf wrote in his excellent analysis in the Financial Times,

One must distinguish between what is worth worrying about and what is not. The decline of the Chinese stock market is in the second category. What is worth worrying about is the scale of the task confronting the Chinese authorities against their apparent inability to deal well with the bursting of a mere stock market bubble.

Indeed, market corrections occur, and while China has been hardest-hit, they are already taking place elsewhere. While such events are unlikely to affect global China's standing much, the Chinese government is under growing pressure to show that it can handle current turmoil -- necessary to convince observers that Chinese policy makers are skilled enough to manage the transformation of China's economy from one dependent on investment to one fuelled by private and public consumption. After all, that is a challenge far more complex than this week's stock market crash.

The international credibility of the Chinese government will determine the speed with which the country can advance in the creation of sinocentric international institutions which, in their entirety, will create a "parallel order" to increase China's autonomy from the Western-led order. The success of these institutions will depend to no small degree on the trust other nations have in China's capacity to take the lead as a global institution builder.

The year 2015 already marks the most important in that sense since the end of the Cold War, with the creation of the Asian Infrastructure Investment Bank (AIIB) and the institutionalization of the BRICS grouping, the most visible elements of which are the New Development Bank (NDB) and the Contingency Reserve Agreement (CRA).

An additional step, still this year, is generally thought to be China's much-hyped international payment system (CIPS) to process cross-border yuan transactions, thus greatly increasing global usage of the Chinese currency due to lower transaction costs. The existing networks make processing yuan payments relatively slow and bureaucratic, thus failing to put the Chinese currency on an equal footing with other global currencies. Cross-border yuan clearing requires an offshore yuan clearing bank in London, Hong Kong or Singapore, or with a bank in mainland China. Seven of the 20 banks selected to participate in the new system initially are foreign.

As Dominic Basulto argues in the Washington Post,

What the creation of such a system means in the short-term is that the Chinese currency (officially known as the renminbi) has the potential to become a truly international, convertible currency and a more attractive currency for conducting international trade and finance. What it means in the long-term is that America’s long reign of economic dominance is at risk.

Just like with other Chinese ambitions such as the plan to transform Shanghai into a global financial center, the desire to turn the yuan into a globally traded currency is natural for a country whose economy is about to become the world's largest. The yuan already accounts for nearly 9% of all trade finance deals worldwide, the second largest behind  the US-dollar. The Chinese currency is also the fifth most used payments currency in the world, behind the dollar, the euro, the pound sterling, and Japan's yen. Still, the yuan is nowhere close to threaten the dominance of the US-dollar. Less than 3% of global payments involve the yuan, compared to over 40% that involve the US-dollar.

It is unclear whether the Chinese government will go ahead with the implementation of the system in the current state of financial turmoil. Rumors are that rather than launching CIPS completely, a limited version of the payments system would now only be used for cross-border yuan trade deals and won’t have capital-related transactions, the sources said.

Still, those who believe that current financial instability will keep the Chinese government from seeking to adjust global structures to its new found economic power are likely to be mistaken. Even if China and the United States were to grow at similar speeds for the coming years, the need for reform would remain in place, and China's institutional representation is, considering its position as the world's second largest economy, still low in both the economic and security realm.

Read also:

Can Shanghai become a global financial center?

BRICS: Time to create an OECD-type structure?

TPP vs. RCEP: Trade and the tussle for regional influence in Asia

Photo credit: Silvery (Zastavki.com)