Europe’s central bank gives Beijing the nod on the yuan with US$557 million conversion

In a first, the ECB included China’s currency in its reserve portfolio, 9 months after the International Monetary Fund granted it reserve currency status

PUBLISHED : Friday, 16 June, 2017, 2:23pm
UPDATED : Saturday, 17 June, 2017, 9:18pm

The European Central Bank has converted 500 million euro worth of US dollars (US$557 million) into Chinese yuan, marking the first time the central bank has included the Chinese currency in its reserve portfolio, nine months after the International Monetary Fund granted the yuan reserve currency status.

The move is symbolic of the central bank’s endorsement of the yuan’s role as a “reserve currency”, although Beijing has imposed rigid capital account controls to make the yuan less freely usable in past months.

The 0.7 per cent presence of Chinese currency in ECB’s reserve portfolio, much lower than the yuan’s 11 per cent share in the basket currency of Special Drawing Rights of the IMF, reflects the ECB’s caution about the yuan, also known as renminbi.

At the same time, the growing trade and investment flows between China and Europe, as well as Europe’s plan to develop “offshore” yuan markets in Frankfurt and Switzerland, have made the European central bank willing to test the waters in yuan holdings.

“It is one of a few developed economies to include yuan reserves…because of its trade and investment exposure to China,” said Xie Yaxuan, chief macro analyst of the China Merchants Securities in Shenzhen. “The proportion is not big, but there is still room to improve.”

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Central banks likely will be the key institutional buyers of yuan assets in the near future. China is also opening its onshore bond market wider to foreign investments.

“The progress of yuan reserves is not as fast as previously thought,” Xie said. “The level of yuan internationalisation, bond market opening-up and the availability of risk hedging tools are key considerations of foreign investors.”

ECB said in a statement that its yuan investment “reflects the importance of China as one of the euro area’s largest trading partners”.

The European central bank also has a “bilateral currency swap deal” with China worth 350 billion yuan, but the deal will expire in October 2019.

China’s rigid control of capital flows has turned many investors away from yuan assets, and the so-called offshore yuan markets have been shrinking. Beijing has stepped up its intervention to push up the value of yuan in the past weeks, but the market appetite for yuan assets remains sluggish, especially after Moody’s downgraded China’s sovereign rating last month.

Outbound direct investment has dropped 56 per cent year-on-year in the first four months of this year, while yuan’s share of international payment currency dropped to 1.6 per cent in April from 2.3 per cent in December 2015, ranking below the Swiss franc at No.7.

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Miranda Carr, senior China strategist of Haitong Securities UK in London, said that yuan is a necessary part of a diversified portfolio for ECB, the Bank of England or the Swiss National Bank.

“They have to have it, no matter they like it or not,” she said.

Carr said that the PBOC appears to be taking a different tack to achieve yuan internationalisation over the long term. While a gradually opened bond market draws many institutional players, an increasing amount of “Belt and Road Initiative” project financing is being made in yuan, driving up yuan holdings outside China.