Yuan decades away from being global reserve currency
Despite the significant progress Beijing has made in broadening global use of the yuan, observers say the mainland currency has more often been chased by speculators than serving as a US dollar-type "safe haven".
The central government has made clear its ambition to boost the yuan's global status to match the growing power of the world's second-largest economy, although People's Bank of China governor Zhou Xiaochuan acknowledged last month that Beijing still had "lots of homework" to do in that area.
Many domestic and foreign economists say the steps rolled out to promote international use of the yuan have been remarkable. However, they also say the mainland needs to deepen its financial reforms to build a deep and liquid enough market and make its monetary decision-making more transparent and independent, among other steps to further liberalise the market, before the yuan can become a global reserve currency.
They estimate the process could take decades.
Beijing has signed bilateral swap deals and set up offshore yuan centres in recent years, after kicking off trials on cross-border trade settlement using the yuan in 2009. About 15 per cent of the mainland's trade was settled in yuan last year.
The PBOC signed memorandums on yuan settlement arrangements with its British and German counterparts last month. It has also signed currency swap contracts with more than 20 monetary authorities around the world in an effort to facilitate trade activities.
Central banks in Japan, Thailand and elsewhere have either included yuan assets in their foreign exchange reserves or are considering doing so.
But investors still have doubts about the yuan's global role.
Greater use of the yuan in recent years has mainly been driven by speculation linked to expectations of appreciation. While it is being used more often in trade settlement, most of the mainland's trade contracts are still invoiced in foreign currencies, and mainland exporters have also been reluctant to use the yuan in their transactions.
"Look at the US dollar. It rises and falls from time to time, but people find it hard to stay away from it. That is a genuine international currency," said Zhang Ming, a senior researcher at the Chinese Academy of Social Sciences, a government think tank.
The yuan had appreciated steadily against the dollar for more than three years before the PBOC reversed the trend this year by stepping in to weaken the currency.
Entrenched expectations of appreciation had prompted trading companies to carry out cross-border arbitrage, taking advantage of the gap between the yuan's exchange rates on the mainland and in Hong Kong, the biggest yuan offshore market, Zhang said.
The limited availability of yuan in Hong Kong makes buying the currency costlier than on the mainland. Some analysts say the difference between yuan and US dollar interest rates has also fuelled speculation.
Eswar Prasad, a professor at Cornell University and former head of the International Monetary Fund's China division, urged Beijing to launch "significant reforms" of its financial system if it wanted to make the yuan a major global currency.
"Before that happens, I suspect we are pretty much stuck in the dollar trap," Prasad told a recent seminar in Beijing.
He cited the dollar's strength and the persistent global interest in holding US Treasury bonds during the financial crisis.
Foreign investors hold about 60 per cent of US Treasury debt, while the share of dollar assets in global reserves has risen in the past few years.
A sound legal system in the United States that governed everybody, including the government, had preserved investors' confidence in dollar assets, Prasad said.
Analysts say investors' trust in the mainland currency has been hindered by the opaqueness of the central bank's operations.
The PBOC is still seen as intervening in the yuan's exchange rate through the setting of the daily fixing, even though the daily trading band has been doubled this year.
It also has to follow economic policy directives from the State Council and lacks the power to make independent monetary decisions.
Trading in the mainland's financial markets is far from active, with many investors in government bonds inclined to hold them until maturity, and sophisticated investment products that would enable people to diversify risk have yet to be designed.
Peking University professor Huang Yiping estimated that based simply on the size of the mainland's economy and capital markets, the yuan should potentially account for as much as 12 per cent of global reserves.
However, if indicators of economic freedom were taken into account, such as the depth of the financial market and the extent of capital account liberalisation, the practical share of the yuan could be "very low" - probably only 2 per cent.
To make the yuan a global reserve currency, Huang said the mainland must have a continually growing economy, further liberalised trade and investment, a sound legal system, a stable and accountable political system, a deep and liquid enough financial market and good institutions that investors had confidence in.
Zhang said he was "not that optimistic" about the yuan's prospects of becoming a global reserve currency any time soon.
"A currency's globalisation would normally take 30 to 50 years," he said.