MNI INTERVIEW: Trade Lifts Use Of Yuan As Reserve Currency

The growth of China’s yuan as a reserve currency is being driven by its use in a developing industrial chain based on cheap Russian raw materials and southeast Asian labour, as the yuan will not be completely convertible for the foreseeable future, one of the country’s most prominent experts on the subject told MNI.

War in Ukraine has diverted more Russian energy and commodities towards a chain forming between the booming downstream labour-intensive industries of southeast Asia and China’s large market and developed industrial base, with the yuan as the settlement currency of choice, said Cao Yuanzheng, chairman of BOC International Research.

While a former drive to internationalise the yuan was hampered by China’s reluctance to make its currency convertible in the onshore market, it could become the standard currency used for trade in southeast Asia and by the members of the Shanghai Cooperation Organization, which includes Russia as well as India, Iran and central Asian nations. (See MNI INTERVIEW: PBOC FX Intervention Still An Option - Guan Tao)

Demand is also building for an alternative to the dollar, whose rapid appreciation as Federal Reserve tightening follows years of quantitative easing has challenged economies around the world, Cao noted.

“The world is looking for new anchor currencies,” said the former chief economist at Bank of China, who now advises several local governments and has followed moves to promote the global use of the yuan for 18 years. “The yuan will play a key role in settlement and clearing in a regional unified currency system, and then further develop as a reserve currency.”

DEEPENING TIES

The exchange rates of countries involved in these deepening trade links are already beginning to correlate more closely with the yuan, he said, taking Russia’s rouble an example.

The yuan accounted for 7% of all foreign exchange trades so far this year, in fifth place and up from the eighth in 2019 in the biggest market-share gain by any currency, Bank for International Settlements data shows. The yuan still only provides 2.88% of global forex reserves, though this is fifth in the world and up 1.8 percentage points from 2016, according to the International Monetary Fund. (See MNI: Yuan weakness Seen Resuming As Exports Slow Amid Outflows)

Driving use of the yuan will depend on a consistent capital account deficit, to maintain overseas liquidity in the currency, and a sound domestic financial market offering investible yuan-denominated securities as well as products like Panda bonds, Cao said.

Maintaining a capital account deficit and international payment balance in a background of narrowing trade surplus will be a policy challenge, though one way to do this would be to promote further Chinese investment in the countries in the One Belt One Road programme, a category which has helped China’s overseas investment exceed foreign direct investment in China since 2015.

CHANG MAI

The Chiang Mai Initiative multilateral currency swap arrangement, seen by some as a step towards an Asian Monetary Fund, could also be extended from its current USD240 billion capacity, and also to include more nations, Cao said.

An associated Asian bond fund aimed at developing local currency debt could be partially denominated in yuan, increasing links between onshore and offshore markets and further cementing Hong Kong and Shanghai as financial hubs for the yuan-denominated assets, he said.

The People’s Bank of China’s role in the process of pushing the yuan global use would be to ensure a stable yuan exchange rate, while providing ample liquidity via its swap tool, Cao said. (See MNI INTERVIEW: China Must Lift Growth To Curb Capital Outflow)

In the longer term, though, the yuan’s acceptance as a reserve currency at a global level will depend on freeing up the remaining controls on China’s capital account, the economist said.