Yuan will need room to spread its wings in Year of the Rooster
Despite naysayers, internationalisation of the yuan is inevitable and the process is under way on several fronts
While Beijing will no doubt be hoping for economic stability this year as it prepares for the 19th Communist Party Congress, the construction of a framework for the internationalisation of the yuan needs to continue regardless, if only as an insurance policy against unexpected developments on the global economic scene.
Not knowing whether United States president-elect Donald Trump’s tweets will prove worse than his bite, there is surely anyway a need to address the reality that China remains over-dependent on US dollar-denominated credit to finance its continued economic expansion, leaving the Chinese economy vulnerable to the vagaries of US policy.
As a Bank for International Settlements Working Paper (BISWP) concluded on December 30 “monetary shocks in a currency significantly affect cross-border lending flows in that currency, even when neither the lending banking system nor the borrowing country uses that currency as their own.”
That conclusion applies particularly to US monetary policy with data cited by the BISWP showing that 47 per cent of global cross-border bank lending was made in US dollars as at the end of 2014.
The internationalisation of the yuan, surely an inevitability anyway given the size of the Chinese economy, will ultimately reduce China’s, and perhaps the world’s reliance on the US currency, whether that be for the pricing of commodities or energy or indeed for loans to finance economic expansion.
And while that prospect will not appeal to those in Washington who grasp that the dollar’s current global hegemony has long fueled the US’ capacity to live beyond its own means, it is inconceivable that the yuan, the currency of the world’s second-largest national economy, is not going to move closer to the centre of the world stage.
While that will not occur overnight, the framework is already being assembled.
Arguments that the yuan’s inclusion in the International Monetary Fund’s Special Drawing Rights basket meant little for the internationalisation of China’s currency in the face of the dollar’s dominance missed the point. The yuan, having cleared the IMF’s standards for SDR inclusion, gave China’s currency an added international sheen.
A separate strand involves the international expansion of yuan clearing.
Qatar and the United Arab Emirates sell energy to China priced in dollars but that hasn’t stopped Doha and Dubai becoming offshore yuan clearing centres. Indeed, by value, 74 per cent of payments from the UAE to China and Hong Kong that went through the SWIFT international transactions network in 2015 were already being made in yuan.
China’s decision in April last year to launch a yuan-denominated gold benchmark is yet another distinct but, in reality, connected strand in the yuan’s internationalisation process and can only help enhance global use of the Chinese currency.
Equally, Russia’s on-going acceptance of yuan in return for oil it sells to China might originally have been influenced by a desire by Moscow to diversify its income stream away from dollars after its annexation of Crimea in 2014 elicited sanctions from the US, but it has shown that pricing crude oil in China’s currency is achievable.
These are all incremental steps towards the internationalisation of the yuan none of which in isolation are decisive but which all form the constituent pieces of an emerging but coherent framework.
Thursday’s decision by the China Foreign Exchange Trading System (CFETS) to expand to 24 the number of currencies in the currency basket which China uses to value the yuan should be seen in the same light.
The US Federal Reserve’s “Broad Index of the Foreign Exchange Value of the Dollar” comprises 26 constituents whereas the old CFETS basket included 13.
Irrespective of the fact the currency markets remain preoccupied by the bilateral dollar-yuan exchange rate, the new CFETS basket now better covers China’s major trade partners and strengthens the representativeness of the yuan’s currency basket.
And while the dollar’s weighting in the CFETS basket may have been lowered to 22.4 per cent from 26.4 per cent, that’s much more closely aligned to the nominal 21.89 per cent the Fed gives the yuan in its own Broad Index.
China’s currency basket-weaving is not arbitrary.
The internationalisation of the yuan will occur at a pace of China’s choosing but it will not be achieved without first creating a framework within which the process can develop.
That process must go on this year, especially when the next incumbent of the Oval Office is an accomplished businessman but new to the art of politics and diplomacy. In the Year of the Rooster, Beijing needs to continue creating the space in which the yuan could spread its wings, just in case China-US trade relations go awry.