Five reasons yuan is no threat to dollar as reserve currency

If I had US$100 billion for every time someone has told me that the yuan is going to displace the US dollar as the world's foremost reserve currency, I reckon I'd have almost as much in foreign reserves as China.

Yet I remain sceptical. For the yuan to become a major reserve currency, China will first have to fulfil several important conditions.

According to a new paper by economists Professor Eswar Prasad and Professor Lei Ye of Cornell University in the US, China's economy must first be big. Second, it must be open, especially to capital flows. Third, it must have a flexible exchange rate. Fourth, it must have broad, deep and liquid financial markets. And finally, China must follow economic policies that inspire confidence in the rest of the world.

Obviously, China already meets the first criterion. It's economy is not only big, it's the second biggest in the world, accounting for around 10 per cent of the planet's gross domestic product and 25 per cent of its economic growth.

China is also increasingly open. Last year its imports and exports of goods and services made up around 10 per cent of all global trade.

What's more, as the first chart shows, the proportion of China's trade being paid for in yuan has risen rapidly, reaching 10 per cent last year.

China is also opening up to cross-border capital flows. Although Beijing retains many restrictions, over the last five years the value of China's foreign assets and liabilities has doubled to more than US$6 trillion.