MNI: Foreign Investment In China Domestic Market Aids Yuan Use

China’s expected further opening to foreign investors in domestic markets should boost yuan's demand and lead to wider global use of its currency in both trade and investment settlement, economists and analysts said.

Yuan internationalization has entered a new stage after over a dozen years of development, albeit through an unexpected path as geopolitical conflicts, the Covid-19 pandemic and populism push the international monetary system into a “new competitive situation,” said E Zhiyuan, chief economist at Bank of China (Hong Kong), in a recent forum.

These changes have depressed the use of the euro and sterling globally, while the dollar and Japanese yen remain key currencies, she said, noting more open domestic markets are necessary to meet demand of overseas investors who are willing to hold the yuan-denominated assets. That suggests room for policymakers to introduce more tools to open Chinese markets and lift regulations curbing onshore-offshore market trade in a bid to accelerate wider acceptance of the yuan, (See: MNI: Yuan Seen Boosted In Q4 If U.S. Enters Recession-Analysts).

PBOC GEARS UP

A fresh pointer on the yuan came this week from the People’s Bank of China on Monday in outlining plans for the second half of the year that included increasing yuan internationalization at a steady pace. Steps will include supporting overseas entities to issue panda bonds in the domestic market, and yuan settlement in both trade and investment.

Swap Connect between the mainland and HK, allowing foreign investors to trade in the mainland internal derivative market, will be launched later this year. At present, overseas players can trade in Chinese markets through the Qualified Foreign Institutional Investors scheme and series of Connect schemes between the mainland and Hong Kong without quota limitations.

Guan Tao, global chief economist at BOC International, said a more flexible yuan exchange rate is needed to attract foreign investors. He said the PBOC could add CNH prices in certain key trading time into its daily CNY fixing formula to better reflect the offshore performance of the yuan and avoid wide gaps between the CNY fixing and CNH levels.

Last month, the central bank implemented policies to expand yuan settlement in cross-border e-commerce and other new trading scenarios, covering more entities and individuals and has mulled extended yuan trading hours to boost overseas use.

OFFSHORE USE

Another indicator for the increasing yuan demand is the booming sale of yuan-denominated debt in overseas markets.

Last week, RUSAL, a leading global aluminum producer, issued first yuan-denominated bond in Russia with total value at CNY4 billion. Last year, Shenzhen municipal government issued CNY5 billion of green bond in HK, the first green Dim Sum bond by Chinese local governments.

In 2022, HK has seen a booming sale of Dim Sum bonds, the yuan-denominated debt sold in HK. Issuance volume is up 145% from a year ago to CNY126.8 billion so far, surpassing the full-year total of 2021, according to data from Refinitiv.

GLOBAL DEMAND

Thanks to the robust exports and the opening of China’s financial markets to offshore investment already, the yuan is increasingly needed.

The International Monetary Fund lifted the weighting of the yuan in the Special Dressing Rights on August 1 to 12.28% from 10.92%. The rising share in goods and service exports from China contributed 65% to the new weighting, while 35% came from more financial transactions in the past five years, Guan said.

Ding Shuang, chief economist for greater China and North Asia at Standard Chartered Bank, said one attraction of the yuan-denominated assets is that their weak link to others currency assets can benefit from the different economic cycles of China, the U.S and EU, helping international investors to smoothen portfolio volatility.

However, he pointed out that whether the yuan could get the nod as a safe-haven currency depends on convertibility of its capital account, which needs Chinese authorities to introduce more financial products for investors to hedge risks in the FX and bond markets.

Liao Qun, chief economist with Chongyang Institute for Financial Studies, said it is now more urgent for China to push the convertibility of its capital account as in the face of geopolitical uncertainty such as economic sanctions.

GO GREEN AND LOCAL

Xu Qiyuan, deputy director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, said the yuan’s cross-border use is restrained by the massive amount of dollar-denominated imported commodities. But a transition from traditional energy to clean energy would be profoundly significant to yuan internationalization.

Other experts see a promising future for the yuan’s global use based on the increasing use of yuan-denominated green products and wider use of E-CNY. These tools are expected to see wider use in a regional trade pact China signed last year known as RCEP.

Tan Xiaofen, professor at Central University of Finance and Economics, said China should seize the low-carbon growth opportunities and develop related yuan-denominated financial products, such as green loans to countries along the One Belt One Road initiative and via green bond issuance.