The Chinese renminbi (RMB) will become the world's third largest currency after the U.S. dollar and Euro within five years as the country accelerates the promotion of its currency unit.

A report by the International Monetary Institute of Renmin University of China and the Bank of Communications, published on Sunday, said that the RMB internationalization index had risen to 1.69 by the end of 2013 from 0.92 a year before.

The main impetus for the internationalization of the RMB comes from cross-border trade settlements and direct investment.

In 2013, China's cross-border RMB trade settlement hit 4.63 trillion yuan (759 billion U.S. dollars), up 57.5 percent year on year, and RMB direct investment totaled 534 billion yuan, up 90 percent year on year.

By the end of the fourth quarter of 2013, direct investments settled in renminbi amounted to 533 billion yuan, (about $88 billion), an increase of 190% against that of the same period of 2012.

The RMB currently ranks fifth in interntional usage, according to the report.

The offshore yuan market has been developing rapidly in recent years, and this year the People’s Bank of China (PBOC) signed a memorandum of understanding regarding yuan clearing and settlement arrangements with the central banks of the UK, Germany, Luxembourg, France and South Korea.

By the end of 2013, the PBOC had signed currency swap agreements involving a total of 2.57 trillion yuan with 23 countries and regions, the report said.

Chen Yulu, president of Renmin University and member of the central bank’s monetary policy committee, said the offshore yuan market in Europe has huge potential since major European financial centres are competing for the market.

In spite of the rapid expansion of the RMB, it still faces four challenges:

1. Lack of an efficient, safe and cost-effective offshore RMB clearing system.

2. The Legal framework for an offshore RMB market has not been established.

3. The offshore RMB financial products chain and the service capabilities of financial institutions must function properly.

4. When offshore financial markets reach a certain size, this will impact the onshore market interest rates and the exchange rate formation mechanism, which will weaken the effectiveness of monetary policy and bring new challenges to financial regulation.

To resolve the problem, China has to build a safe, efficient and low-cost offshore RMB clearing system as soon as possible.

In addition, regulators must create a legal framework for the offshore RMB market and establish sound regulations to stop money laundering and tax evasion via offshore yuan transactions. 

The article is edited and translated from the Chinese version of 《人民币有望成第三大国际货币（经济聚焦）》,source: People's Daily.