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The Chinese yuan, also known as the renminbi, is already convertible under the current account - the broadest measure of trade in goods and services. However, the capital account, which covers portfolio investment and borrowing, is still closely managed by Beijing because of worries about abrupt capital flows.

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Yuan decades away from being global reserve currency

PUBLISHED : Friday, 11 April, 2014, 10:18am
UPDATED : Saturday, 12 April, 2014, 1:42am

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.

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This article is now closed to comments

534c6a96-144c-4954-892b-08ee0a3209ca
I feel this report is completely false. China is aggressively buying gold reserves and gold mining operations. They want to keep this secret to keep gold prices down. I am very concerned that they plan to position themselves for currency reserve much sooner than expected. US has mounted massive federal deficit that will cause enormous impact to US economy!
keresearch
swapping hong kong dollars via a controlled mechanism and return them back to Rmb is restricting internationalisation not furthering it.
singleline
Will the future ‘through-train’ direct share-trading between Hong Kong and Shanghai help China in her effort to open the capital account and internationalize the yuan ?
Perhaps.
But Hong Kong is still a part of China --- one-country, two-systems.
Any capital movement (flow of yuan) between Hong Kong and Shanghai is still within the country, not cross-border capital flow.
And I think Hong Kong and foreign-country reserve-currency managers mostly invest in the highest-quality central government treasuries, and bonds issued by the quasi-governmental organizations (like US’s Freddie Mac and Fannie Mae).
They may also buy the lower-quality local government municipal bonds and some big-companies’ corporate bonds.
To them most stock markets' shares maybe a bit too risky.
Does the foreign portfolio of Hong Kong’s Monetary Authority consist mainly of foreign countries’ company shares and only a minority of foreign-country long-term central-government treasuries?
I don't know --- but I hope it doesn't !
XYZ
It is impossible for a totalitarian state to have a global reserve currency. The risks are simply too great. Until China has a stable political environment based on a reliable rule of law and the sanctity of contract enforced by an independent judicial system, the best it can hope for is a wider international acceptance based on the risk-adjusted perception of short-term stability. Which may well be enough for the CCP's purposes. But a global reserve currency? Forget it.
impala
Single line? Not exactly.
singleline
Thank you.
I think you know why I want to present my ideas this way.
Perhaps this style can prevent some of the readers from falling asleep.
singleline
If the US dollar’s rise to the world status of global reserve currency, and its persistence, is any guide (of course the yuan may follow another route), then
China needs to have policy blunders committed by the US and the EU,
win the third world war,
a Chinese-style Bretton Woods system,
a Chinese-style Marshall Plan,
a Chinese-style Korean and Vietnam War,
run a trade-deficit year-in and year-out (the economy is mainly domestic-consumption driven),
more and more overseas direct investments,
central and local government budget deficits year-in and year-out,
much deeper and more sophisticated yuan-denominated money and treasury market,
another world oil crisis,
propping up of Euroyuan and Asianyuan market,
a Chinese-style Plaza Accord,
win the Cold War,
a Chinese-style Iraq and Afghanistan war victory,
well-equipped fleet of aircraft carriers and other military weapons,
a political and judiciary system which is …,
a powerful and independent central bank, backed up by a tax-levying powerful government (the present division of labour between the PBOC and the CBRC seems a bit strange to me),
...
singleline
Does China have a deep and sophisticated debt (bond) market like the US?
A genuine market-determined yield curve?
Reliable credit-rating agencies?
Bankruptcy and related laws?
Well-developed derivative markets?
And politically, …
As I had said before, China should mend her own house first before she cares about the external garden.
As is said in Akira Kurosawa’s 'Seven Samurai', if your head is at risk, it’s foolish to worry about your moustache.

singleline
Recently the PBOC chief Zhou Xiaochuan says that China will accelerate her effort to open up the capital account and internationalize the yuan.
I hope he doesn’t mean what he says.
2020 may be an important year for some people in China, but it’s certainly not a good deadline for the effort of yuan internationalization.
Suppose the Hong Kong Monetary Authority wants to change the present linked–exchange rate system right now, by linking the Hong Kong dollar to the yuan, instead of the US dollar, in response to China’s yuan-internationalization effort.
But what kind of Chinese assets can Hong Kong’s reserve-currency managers invest in at present ?
Don’t forget that we’re talking about trillions of dollars !
And what about the needs of the reserve-currency managers of other foreign countries?
singleline
...

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