While most Foreign exchange traders have focused on the effective devaluation of the Japanese yen in recent months, an equally interesting and perhaps more significant story is playing out with the Chinese renminbi. Although China and Japan are trade rivals, the Beijing government has let the renminbi appreciate substantially against the U.S. dollar even as the yen has fallen dramatically. The renminbi is up more than 1.5 percent since the beginning of the year and hit a 19-year high on May 8.

One explanation for the rise is China’s capital account surplus, which surged by $101.8 billion in the first quarter, compared with $56 billion during the same period last year. Remarkably, the renminbi appreciated even though the People’s Bank of China reported buying 1.2 trillion yuan ($193.6 billion) of foreign currency in the first quarter, the biggest amount ever. So the renminbi might have climbed even higher if the government hadn’t intervened.

“There was a return to a large trade surplus and a current-account surplus as well, with money coming back into China which had left in the third quarter of last year,” says Stephen Green, Hong Kong–based head of Greater China research for Standard Chartered.

Standard Chartered's Stephen Green

Another driver of the renminbi’s appreciation is its interest rate differential with the dollar. Chinese corporations now get about 100 basis points more on renminbi deposits than on the greenback, so they’ve been shifting from dollars into local currency, says Paul Mackel, Hong Kong–based head of Asian currency research for HSBC Holdings. “Despite the strong inflow pressures in the first quarter, FX policy has been fairly tolerant of allowing the currency to appreciate, suggesting the authorities are comfortable with the currency getting stronger,” Mackel says.

Mitul Kotecha, head of global FX strategy at Crédit Agricole Corporate and Investment Bank in Hong Kong, says another cause may have been Chinese concerns over a recent U.S. Treasury Department report examining the question of whether Beijing was manipulating its currency. Kotecha believes China let the renminbi appreciate before the report was issued to help make its case. (The Treasury’s April report didn’t find currency manipulation.)

At the same time that they’re allowing the renminbi to appreciate, the Chinese have embarked on a series of steps aimed at making their currency more international. For example, China has signed currency swap agreements with a number of countries; the latest, with Brazil, creates a 190 billion-yuan swap line. Beijing is also allowing a growing number of countries to hold Chinese sovereign debt as part of their central bank portfolios. These moves are increasing the demand for renminbi overseas.

For institutional investors a more important development was the China Securities Regulatory Commission’s March announcement that it will let international banks and asset managers join its renminbi qualified foreign institutional investor program. RQFII allows institutions with offshore renminbi holdings to invest them on the Chinese mainland. The rule change is expected to prompt the launch of exchange-traded funds in Chinese A shares and bonds.

The renminbi is still only a small part of the foreign exchange market, but strategists see its internationalization taking on greater importance. “Symbolically, these moves are quite significant,” says HSBC’s Mackel. “When you look five years into the future and add up all these little developments, they will lead to this currency being used a lot more in the global financial system.”

In another change that could affect the renminbi, Chinese central bank officials have indicated that the PBoC will widen the trading band in which the currency can move on any given day. The band was increased from 0.5 percent to 1 percent in April 2012. At a panel discussion during April’s International Monetary Fund meetings in Washington, Yi Gang, head of China’s State Administration of Foreign Exchange, predicted that the band would widen again soon. “I think the exchange rate regime will continue to reform in the direction of a market-oriented direction and make market demand and supply to a large extent determine the rate,” Yi said.

On May 6 the central government’s cabinet, the State Council, said it would soon reveal details of the timetable for full convertibility of the renminbi under the capital account. The council also said it will allow individual investors to invest overseas for the first time. “They’re pushing careful capital account liberalization,” says Standard Chartered’s Green. “The internationalization of the renminbi will make it easier for foreign investors to buy renminbi assets and for Chinese investors to take money offshore to buy foreign assets, and allow central banks throughout Asia to come in through the capital account controls and enter the Chinese bond market.”

For now, at least, things seem to be looking up for the renminbi.