MNI: China Needs Yuan Asset Pool To Drive Currency Ambitions

China will need to offer more investment options for yuan holders, including expanding its offshore bond market, to support the expected increased use of the yuan in settling oil and gas trade with Gulf countries, but the internationalisation of the currency must be done at a gradual pace that doesn’t threaten the stability of the yuan or the financial system, advisers told MNI.

Chinese President Xi Jinping called for increased use of yuan settlement with the six Gulf Cooperation Council (GCC) states within three to five years at December’s China-GCC summit, though the People’s Bank of China remains cautious about threats to yuan stability given the currency’s limited liquidity and the lack of a matching pool of yuan-denominated assets that would provide GCC nations with the opportunity to invest their increased yuan cashflows, advisers said.

GROWING TRADE

Saudi Arabia and China share a broad vision to accept yuan payment for some energy trade as U.S. demand for Saudi oil has declined as it has become a net oil exporter, said Wang Yongzhong, head of international commodity research at the Institute of World Economics and Politics, Chinese Academy of Social Sciences. He said Saudi Arabia could use the yuan received to pay for increasing imports of manufactured goods and labour from China.

China’s oil imports from the six Gulf nations exceed 40% of its total oil purchases, with Saudi Arabia accounting for about 17% of China’s oil imports, according to Wang.

The yuan is increasingly attractive as it has shown greater stability compared to other non-U.S. dollar currencies and is being promoted as an alternative for countries seeking to diversify their foreign exchange reserves, said Zhao Xijun, co-president of China Capital Market Research Institute.

HURDLES REMAIN

Strengthening the yuan’s investment and financing uses will be needed to promote its broader adoption in trade.

An overseas pool of yuan-denominated assets is necessary to match the accumulation of offshore yuan expected as its use in global trade grows, said CITIC Securities chief economist Ming Ming, who previously worked at the PBOC. These pools are often established via the development of offshore bond markets, Ming explained.

As of December 9, China’s CNY451.6 billion of offshore yuan bonds were mainly issued in Hong Kong, Taiwan and Singapore by the government and financial institutions, with small sales by enterprises, according to Ming.

Wang suggested larger sized and more consistent offshore bond issuance by local governments, state-owned enterprises and policy banks was needed to develop offshore yuan markets, as well as preferential policies for Gulf nations to invest in China’s domestic financial market.

Zhao argued that it was better to set up a cross-border investment channel specifically for overseas companies and financial institutions participating in the energy trade to access the domestic market in a closed loop. “This is more favorable for the central bank at this current stage to balance the need to keep the yuan stable and ensure financial stability,” he added. (See: MNI INTERVIEW: Yuan Could Rally To 6.5 But Volatility Ahead)

PRICING POWER

The prospective long-term use of the yuan in pricing oil trades will depend on whether the oil market becomes a buyers’ market with the arrival of peak oil demand and greater adoption of carbon neutrality, said Wang.

China’s oil purchases from the Middle East mainly use the U.S.-denominated Brent and DME Oman crude oil futures contracts as the pricing benchmark. China, as the largest importer of oil and gas, should have some bargaining power to price a proportion of its purchases in yuan via negotiations, said Wang, noting that the price of crude oil futures introduced by Shanghai International Energy Exchange in 2018 could serve as a benchmark.

“It is too optimistic and too early to say the yuan’s increasingly international role will pose a clear and present challenge to the dollar in energy trade,” said Wang, adding that it is unlikely “until the yuan enjoys higher level of convertibility with deeper opening of the country’s financial system.”