Chinese yuan still far from being a global currency despite inclusion in IMF’s SDR basket
Chinese yuan will formally join the Special Drawing Rights basket of the International Monetary Fund on Saturday, becoming the fifth SDR reserve currency.
Seen as a milestone in Beijing’s push for yuan’s internationalisation, the move will be a catalyst for central banks and funds around the world to shift funds into yuan, which in turn will promote its use worldwide.
However, to China’s disappointment, global use of the currency actually declined in the past year amid lingering concerns over depreciation. Analysts say SDR status won’t give the yuan an immediate boost because Beijing’s tougher controls on capital flows and a lack of transparency in monetary policies are still dampening global investor confidence in the currency.
“It’s a positive sign and a good start, but it won’t make a big difference in terms of demand for the yuan and its liquidity,” said Heng Koon How, a senior foreign exchange strategist at Credit Suisse in Singapore.
“SDR is only a small part of global central bank reserve assets, the amount is relatively moderate and it’s not very liquid,” he added.
The direct demand for yuan asset allocation in the IMF, BIS, the World Bank and other funds around the world that track SDR is expected to be over US$10 billion, according to Dai Daohua, a senior economist at the Bank of China (Hong Kong), citing figures from the People’s Bank of China.
Looking back, China took major steps to try and gain entry into the SDR basket, including allowing the reference rate of the yuan to be more market-based and expanding access to the bond market for overseas investors. However, the yuan’s internationalisation has actually slowed in the year since the IMF’s decision.
Total offshore yuan deposits shrunk 31 per cent in July compared to the same month a year earlier, according to statistics from RBC Capital Markets. Yuan deposits in Hong Kong have been on a steady decline, down 33 per cent in July year on year, according to data from the Hong Kong Monetary Authority.
The amount of yuan settlement in cross-border trade fell 40.1 per cent in August compared to a year ago, with the share of total trade settled in yuan falling to 22.1 per cent from a peak of 32 per cent, according to RBC Capital Markets.
Data from SWIFT payments, the global financial network that banks use to transfer capital, shows that the yuan’s share of global payments fell to 1.9 per cent in July from a peak of 2.8 per cent in August 2015.
The setback could be partly attributed to lingering concerns over depreciation which led to intervention by the People’s Bank of China and tougher controls over capital flows.
The yuan’s value has been declining since the PBOC surprised the market with an one-off depreciation in August last year. Since thenthe currency has depreciated by over 7 per cent in both onshore and offshore markets.
After significant weakening in the past year, downward pressure still exists.
“The yuan is still slightly overvalued compared to other currencies such as euro and yen, but it will depreciate in a more orderly way,” said Heng, who expects the yuan to finish the year at 6.75 against the US dollar and weaken further to 7.00 by the end of 2017.
A similar outlook is seen by Bank of China. “Depreciation pressure is quite moderate now and we expect the yuan to close 2016 at 6.7 per cent against the US dollar and weaken another 2.5 per cent in the next year,” said Dai.
In addition to concerns over depreciation, there are other fundamental issues hampering global investor confidence in the currency.
For the yuan to be a major international reserve currency China would need to “fully open its capital markets and convince world markets that the openness would remain during any period of stress”, said William Overholt, a senior fellow at Harvard University’s Asia Centre and author of the book Renminbi Rising.
Wang Tao, chief China economist at UBS in Hong Kong, said global demand for yuan is highly dependent on more fundamental factors, such as availability of yuan-denominated assets and their liquidity.
Last year, China granted long-term foreign institutional investors access to its interbank bond market, but overseas ownership of the national debt accounts for only 1 per cent of its outstanding notes by the end of June, according to Bloomberg data.
“China has opened up channels for global investors to buy Chinese bonds and to trade in the onshore foreign exchange market, but the channels for getting capital out are still quite narrow, which is a big concern for global investors,” said Heng.
In addition, global investors still think China’s monetary policies are hard to understand.
“Many overseas investors that we have seen expressed concerns about a lack of transparency in China’s monetary policy, which makes them hesitant about investing inside China,” said Dai.