Beijing’s bold steps to globalise the yuan, such as its launch of yuan denominated crude oil futures and its highly anticipated issuance of a digital currency, are in the limelight. But experts say that China has a long way to go to achieve its ambition to make the yuan a key global currency
For a decade, China has been promoting the globalisation of the yuan. The strategy has a binary purpose: It aims both to challenge the US-led world economic order and to enhance the yuan’s status to match the size of the Chinese economy.
“China is well aware of the power of the dollar as the key currency,” a forex markets expert said. “Economic sanctions against Iran and other countries that are hostile to the US can work because the dollar is the key currency used in trade payments and financial transactions.”
According to the Bank of Communications [BOCOM], one of the five largest Chinese commercial banks, the People’s Bank of China has set up yuan clearing banks in 25 major countries, including the United States, Britain, Singapore, Germany, France, South Korea, Japan, and Russia, in an attempt to globalise the yuan.
Thirty-one institutions are directly participating in the yuan Cross-Border Interbank Payment System (CIPS), while 847 are indirectly participating.
But Hong Kong remains the largest yuan-clearing centre globally, with a 76.36% share of yuan activity outside the mainland, followed by London at 6.18% of activity, according to the SWIFT interbank network. The offshore yuan centres are playing a critical role in facilitating the global usage of the yuan.
“China is ambitious to globalise the yuan and is taking steps to achieve the goal,” South Korean Hur Kyung-wook, a former Ambassador to OECD and a Vice Finance Minister, said.
“But, for a country to globalise its currency, economic power is not enough: It has to secure infrastructures like well-developed capital markets and a reliable financial system.”
By the Numbers
Looking at the yuan through the key metrics that determine the globalisation of a currency presents a mixed picture.
The yuan’s trade payments volume rose 33.5% per annum to reach 5.11 trillion yuan ($730 billion) in 2018; that number stood at just 506.3 billion yuan in 2010.
The yuan’s status as a reserve currency is soaring. Yuan holdings as a reserve currency in those countries that report on the currency compositions of their foreign exchange reserves fell short of $100 billion in value at the end of 2016. However, the figure had soared to $217.64 billion as of September this year.
More than 60 central banks or monetary authorities around the world now include the yuan in their foreign exchange reserves. Even so, the yuan accounts for as little as 1.97% of total global foreign exchange reserves.
Meanwhile, its share in the global payments market is lower than 2%. At the same time, the mighty US dollar has also been strengthening its international status. The dollar accounts for 41% of international payments, 43% of global foreign exchange transactions, and 62% of reserve currencies, according to China’s BOCOM.
“The level of the globalisation of the yuan does not match the status of the Chinese economy,” admitted Tang Jianwei, Senior Economist of BOCOM, in a presentation at a conference on the yuan/won market, held in Seoul this month. “The yuan’s international status has been enhanced, but has not reached the level of China’s overall economic power.”
Now, some are seeing China’s launch of yuan-denominated crude oil futures and its issuance of a digital currency as long-term plays to underwrite the globalisation of the yuan.
Powering up Yuan
China established oil futures, trad-able in yuan, on the Shanghai International Energy Exchange (SINE) a branch of the Shanghai Futures Exchange (SHFE) in March last year. It also allowed foreign traders to participate in the market, a first for Shanghai commodities futures.
Currently, the SHFE trades 14 commodities futures, including aluminium, nickel, electrolytic copper, zinc. Foreigners, however, are barred from these trades.
Beijing has exempted taxes on foreigners’ transfer and brokerage income in an effort to lure global capital into the yuan-denominated oil futures, Seo Byeong-ki, Professor at Korea’s Ulsan National Institue of Science and Technology, wrote in a contribution to the Korea Petroleum Association’s magazine.
“Petro-yuan” is the Chinese strategy to counter the “petrodollar” the common practice under which oil is paid for in the US currency. There are sceptical views on the yuan-denominated oil futures trades.
“Pessimistic views on the petro-yuan are prevalent among experts who point out the Chinese authorities’ strong and unilateral foreign exchange market interventions, and the underdevelopment of China’s financial and foreign exchange systems,” Seo noted.
Still, Seo sees possibilities. “There are convincing views that it will develop in a way different from previous threats to the petrodollar as China is currently the largest importer of crude oil, and the yuan is included in the SDR (Special Drawing Rights) currency,” he noted. The SDR is one of the IMF’s international reserve assets.
”Also, Russia and Saudi Arabia accept some yuan payments, due to rising US crude oil self-sufficiency and to geopolitical reasons.”
Moreover, given the centrality of oil to the global economy, the Chinese venture into petro-yuan can be seen as a smart one.
“When the US dollar started to be used for the payments for oil trade, it paved the way to be the key currency,” Lee Chi-hyun, Researcher at the Korea Center for International Finance, said. “This move would have some implications for globalising yuan if the market settles.”
According to a report published last week by Forkast.News, a Hong Kong based emerging technology focused media and research platform, the People’s Bank of China is expected to issue a digital currency within the next few months.
While other central banks have mulled central bank digital currencies, or CBDCs, Beijing could be a global pioneer – depending upon if and when it issues.
Unlike cryptos, CBDCs are underwritten by central banks, granting them status as legal tender. Moreover, CBDCs are expected to offer benefits in terms of transactional efficiencies, central bank oversight, technological innovation and financial inclusion.
Beijing’s plan is seen as being for both domestic and international reasons. The PBOC is aiming to tighten down on runaway local currency flows while also seeing off perceived challenges from other global digital payment platforms, especially Facebook’s Libra. However, the PBOC may also hope that its digital currency will help globalise the yuan.
Angie Lau, Veteran Asia Finance and tech journalist and commentator, and editor-in-chief and founder of Forkast.News, notes that for the yuan to supersede the dollar “is a bit of a stretch for a number of reasons,” but she adds that the digital currency “isn’t necessarily about that.”
“Rather, the point of it is to provide extra liquidity for the yuan so that it’s a competitive alternative to the dollar particularly in emerging markets within China’s sphere of influence.”
Only after this framework is in place, says Lau, can “a new race be run” between the dollar and the yuan.
Experts say that China’s highly ambitious and widespread Belt & Road Initiative, combined with a digital currency, could promote the yuan’s globalisation.
“If China’s CBDC is successfully issued and used with no security concern, it will enhance the reliability and usability of the yuan and partly contribute to the globalisation of the yuan,” Lee of KCIF said.
Sayuri Shirai, a visiting scholar at the Asian Development Bank Institute and a professor at Keio University agreed. “Given that China’s economy now accounts for about 15 percent of global GDP and its influence is expanding rapidly in emerging economies with the Belt and Road initiative, the CBDC may boost the internationalisation of the yuan,” she wrote in the Japan Times.
Trade between China and Belt & Road linked countries rose 9.4% in the January-October period this year. China’s trade with these countries stood at 29.1% of total Chinese trade volume, up 4.1% from 2013, according to BOCOM.
Beijing’s ambitions for the yuan are also buttressed by the overweight dollar. Shirai added that today’s dollar dominance is out sized, given that the US economy accounts for only a quarter of global GDP.
Even so, plentiful arguments state that the globalisation of the yuan still faces multiple challenges. First and foremost, Chinese authorities restrict yuan conversion and capital outflow.
According to Lee of KICF, China does not regulate yuan convertibility for trade payments, but imposes restrictions on conversion for capital transactions.
China also keeps tight capital controls on residents, while administrative procedures for non-residents’ capital outflow are difficult and cumbersome widely considered an indirect regulation.
Further issues are what underwrites the currency particularly given Chinese authorities controls over the exchange rate. “Fundamentally speaking, for the globalisation of yuan, its value should be stable, and there should be quality yuan assets so that yuan holders can make investment profits out of yuan holdings,” Lee said. “Otherwise, people will not want to hold yuan.”
Moreover, reform is required in Chinese market practices. “Economic stability, a reasonable foreign exchange policy, and the opening and the development of the Chinese capital market are musts for the globalisation of yuan,” Lee said.
Beijing is, in fact, accelerating the opening of China’s capital markets. It abolished the limit of investment in both dollar and yuan for qualified foreign institutional investors in September last year.
And global indexes are giving Chinese financial instruments the thumbs up. Morgan Stanley Capital Index upped Chinese A-shares inclusion to 20% in three-phased steps over 2019; the FTSE has also included Chinese A-shares in its index. A shares also known in China as “domestic shares,” are yuan-denominated, rather than foreign-currency denominated, and trade on the Shanghai and Shenzhen exchanges.
In April, the Bloomberg Barclays Capital Aggregate Index began including Chinese bonds.
This is all adding up. According to Lee, currently, foreign investors’ holding of Chinese bonds and stocks now account for 3% of total Chinese securities – a one-third rise from 2% early this year.
Even so, Lee pointed out that much remains for global investors to have full confidence in Chinese capital markets. “They need to introduce a more reliable and transparent credit rating system and push for the restructuring of the large state-run corporates which issue the majority of Chinese bonds and stocks,” he said.