MNI SOURCES: China to Resume Yuan Intern'lization Push in 2018

-- PBOC Asking State-Owned Banks to Amass CNY300 Billion Fund for Belt and Road

Loans

-- Launch of Yuan-Denominated Oil Futures Market in Shanghai Possible Next Year 

     BEIJING (MNI) - The Chinese government's push to internationalize the yuan,

which has stalled over the past two years, is likely to resume in 2018 as China

ramps up efforts to implement its Belt and Road Initiative (BRI), President Xi

Jinping's signature foreign policy strategy, Chinese sources told Market News

International.  

     The People's Bank of China has asked state-owned banks to provide

yuan-denominated funds totaling about CNY300 billion to be granted as loans

mainly for infrastructure projects linked to the BRI, a source with knowledge of

the matter who declined to be identified told MNI. The aim is to increase the

liquidity of the Chinese currency in overseas markets, he said. 

     "Exactly how the funds would be used is still under discussion, but the

focus would be on infrastructure investment in countries along the Belt and Road

to inject liquidity and expand the use of the yuan overseas," the source said.

"It is seen as an important step to accelerate the yuan's internationalization."

     The People's Bank of China did not respond to MNI's request for comment on

the fund.

     BELT AND ROAD INITIATIVE INTERNATIONALIZATION FOCUS

     The BRI, previously known as One Belt One Road, was first proposed by

President Xi in late 2013 as a sweeping geopolitical initiative to build

infrastructure that would spur investment and trade in as many as 65 countries.

The Belt part will link China with Europe via several land corridors through

Russia, Central Asia, the Middle East and Central Europe, while the Road, a

maritime Silk Road, would comprise two sea routes - one through the Middle East

and Africa and one linking China to the South Pacific. 

     The Chinese government hasn't announced any concrete targets for projects

or for the amount of investment required, but as the instigator of the

initiative, it has been at the forefront of efforts to drum up funding, setting

up a special Silk Road Fund, ordering its two biggest policy banks - China

Development Bank and Export-Import Bank of China -- to offer loans and

encouraging the Asian Infrastructure Investment Bank, another China initiative,

to offer loans. 

     At the Belt and Road Forum in Beijing in May 2017, the government pledged

an additional CNY940 billion, equivalent to $136.5 billion, in financial support

for the initiative, according to  HSBC. 

     PUSING BANKS TO OFFER CNY LOANS BUT FOREIGN DEMAND UNCERTAIN

     Nearly all the lending so far has been done in U.S. dollars, with banks

raising money through the issue of dollar bonds overseas or by using their

domestic firepower to offer loans in U.S. dollars. But waves of capital outflows

from mid 2014 to end 2016 saw China's foreign-exchange reserves slump by almost

$1 trillion to $3 trillion, and with the authorities reluctant to see the

reserves drop any lower, banks are being discouraged from offering foreign

currency loans. 

     Pushing borrowers to use yuan for their BRI projects would get around

domestic restrictions on foreign-exchange transactions and help the government

kick-start its stalled yuan internationalization strategy. 

     Issuing yuan loans would remove the currency risk on lending for Chinese

banks, but whether foreign borrowers would be prepared to take on the risk

remains to be seen. They may also find yuan loans unappealing, especially as

Chinese interest rates are so much higher than U.S. interest rates. 

     The U.S. Federal Reserve's federal funds rate target range is currently 1%

to 1.25% and the prime loan rate is 4.25%, while in China, the benchmark

money-market interest rate, the volume-weighted seven-day deposit reverse repos,

stood at 2.8332% on Monday morning and the benchmark one-year lending rate is

4.35%. 

     "Borrowing costs in yuan are much higher than in U.S. dollars because

China's money market rates are rising under the pressure of financial

deleveraging, which would drag up the actual lending rate in yuan," a manager in

the loans department at a joint-stock bank told Market News. "On top of that,

foreign borrowers have to consider the exchange rate, especially if the yuan

strengthens. 

     "But Belt and Road is a strategic initiative and the government will have

special policies, so making profits through the yuan loans is not the priority.

Chinese banks may have to offer lower loan interest rate," he said. 

     MOVEMENT ON OIL FUTURES PRICED IN YUAN 

     Another sign that the government is ready to restart yuan

internationalization is progress on a long-awaited proposal to set up a domestic

oil futures market open to international firms with contracts settled in yuan

and also to introduce an oil benchmark priced in yuan. The China Daily reported

in September that trials of a digital trading platform were completed in July

and the Shanghai International Energy Trading Center is now awaiting final

approval from the State Council. 

     Some countries, such as Russia and Venezuela, are already selling oil to

China and accepting yuan, and while most analysts say a domestic futures market

wouldn't be a game changer, it's another incremental step toward

internationalizing the yuan and decreasing the dominance of the dollar. 

     "One of the main impacts of the proposed new crude futures contract, and

presumably one of the intentions behind the proposal, is that by providing a

yuan-denominated financial hedging tool for crude oil, this will likely help to

promote the appeal of the yuan as a pricing currency in global oil trade,"

analysts at Societe Generale wrote in a report in October. 

     YUAN INTERNATIONALIZATION STALLED AFTER MID-2015

     China's efforts to internationalize the yuan have progressed in fits and

starts over the past decade. The most symbolic move came in November 2015 when

the board of the International Monetary Fund approved the yuan's inclusion in

the basket of currencies used to value its synthetic reserve currency, the SDR,

effective Oct. 1, 2016. But since then, the yuan has retreated from the

international stage as China battened down the hatches in the face of sustained

depreciation pressure on the yuan and surging capital outflows. 

     Data from the SWIFT global payments network show that the yuan's share of

international payments peaked at 2.79% in August 2015, ranking fourth behind the

dollar, euro and pound. But the PBOC's decision that month to change the way it

set the yuan's daily fixing, which led to a de-facto devaluation of around 2%,

shook global markets and eroded confidence in the currency. The yuan's share

fell to 1.46% in October this year, the third consecutive monthly drop and the

lowest since April 2014. The yuan fell to the seventh most-used currency from

sixth in September. 

     Although China has opened up the domestic market wider to foreign investors

through initiatives such as the stock and bond Connect programs, it has so far

failed to allow domestic investors to move money overseas and let banks move

more yuan offshore. 

     International Monetary Fund data show that foreign-exchange reserves held

in yuan were the equivalent of $99.36 billion at the end of June 2017, up from

$84.51 billion at the end of December 2016, although that's only just over 1.07%

of the world's total allocated foreign exchange reserves. Foreign investors

increased their holdings of Chinese bonds for a ninth straight month in November

to CNY936.6 billion ($140 billion), according to China Central Depository &

Clearing Co.

     In contrast, yuan deposits held outside of China, a key element in

internationalizing the currency, have slumped partly due to a decline in

cross-border trade settled in yuan and partly due to the PBOC's restrictions on

domestic banks. In Hong Kong, where the majority of offshore yuan is held,

deposits rose to as high as CNY1 trillion at the end of 2014 but have fallen to

almost half that level in 2017 and stood at CNY535.5 billion in September. 

     YUAN OFFSHORE LIQUIDITY INSUFFICIENT TO SUPPORT INTERNATIONALIZATION

     "The biggest obstacle in the way of yuan globalization is insufficient

stock of yuan deposits in offshore markets to provide liquidity, transparent

pricing, and allow payments to be made and reserves to be held in the yuan," a

forex analyst with a large joint-stock bank who did not want to be identified

told MNI. "The stock has been falling over the past two years because of the

PBOC's regulatory measures to stem capital outflows. That's drained yuan

liquidity, which has been a direct cause of the step backwards in

internationalization." 

     Unless China makes more of its currency is available overseas by running a

current account deficit rather than a surplus, there won't be enough yuan in

international circulation to allow it to be held in massive quantities, some

economists argue. But the country has been running surpluses for years and the

government may not be prepared to shift to running deficits. 

     "The central bank is concerned about running current account deficits and

also about completely opening up the capital account," the forex analyst said.

"So it would be very difficult to see the yuan becoming like the currencies of

developed western economies, at least in the next 10 years, although of course

that depends on the government's target. But I think the PBOC will be happy to

see some progress in the internationalization of the yuan." 

--MNI Beijing Bureau; +44 203-586-2244; email: nerys.avery@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

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