Internationalizing Like China

We empirically characterize how China is internationalizing the Renminbi by selectively opening up its domestic bond market and propose a dynamic reputation model to explain China’s internationalization strategy. While previously closed to foreign investors, there have recently been major increases in foreign investment in China’s domestic bond market. The Chinese government carefully controlled the entry of foreign investors into its market, first allowing in relatively stable long-term investors like central banks before allowing in flightier investors like mutual funds. By the time China allowed in flighty foreign investors, the Chinese RMB was treated relatively more like a developed than emerging market currency. Our framework explains these patterns as the result of a government strategy to build its reputation as an international currency issuer while minimizing the cost of potential capital f light as it gains credibility.