Beijing’s meddling means the yuan may never be a truly global currency
The Chinese government’s resistance to a fully market-determined exchange rate limits the willingness of international markets to adopt the yuan
“The [yuan] is rising but will not rule,” wrote Cornell University’s Eswar Prasad in the March edition of the International Monetary Fund’s Finance and Development magazine. Since then, there has been renewed evidence of Beijing’s proactive approach to managing the currency’s value that arguably underscores Prasad’s assertion.
Of course, the People’s Bank of China has its reasons for engineering the recent moves in the yuan and tweaking the mechanism that guides the way its value is set at the daily fixing. And the central bank is under no obligation to share its thoughts explicitly.
That leaves a vacuum into which analysts have poured, filling many column inches speculating on the drivers of recent events.
But it is the very fact that Beijing’s fingerprints are all over recent moves in the yuan, rather than the reasons for such interference, that is likely to exercise the greatest influence on foreign investors.
As Prasad wrote in his article, a sense that “the Chinese government seems unwilling to condone a fully market-determined exchange rate” was already one of the constraints on the willingness of global markets to adopt the yuan.
In his view, for the attractiveness of a currency to be enhanced to the global investing community, “foreign investors must be able to acquire and easily trade financial instruments denominated in that currency without major restrictions on cross-border financial flows”.
“And they must be reasonably confident that the currency’s value will not be controlled by a government with scant regard for market forces,” Prasad added.
By that measure, last week’s events will not have enhanced the attractiveness of the yuan.
A working paper published on Friday under the auspices of the Bank for International Settlements, often referred to as the central banks’ central bank, concluded that “external factors, such as the US shadow federal funds rate, appear to have played a significant role in Chinese monetary policy decisions since 2002”.
That might give credence to the idea that one of the reasons Beijing acted to engineer a move higher in the yuan’s value against the US dollar was to pre-empt the possible impact on the yuan that could accrue from the next rise in US interest rates, which is widely held to be imminent.
Of course, that does beg the question of why the same tactic was not used by Beijing ahead of other recent and well-flagged US rate rises.
Perhaps China concluded that with a broader ebbing of currency market bets on the dollar, as doubts have grown about the potential for any swift enactment of US President Donald Trump’s reflationary agenda, the bilateral dollar-yuan rate also needed to adjust lower.
If so, that leaves unanswered the question of why the currency market had not pursued such an adjustment itself.
At any rate, currency market practitioners had a wake-up call in more ways than one.
Prasad’s article argues that “foreign investors typically want to know they will be treated fairly according to well-established legal procedures rather than subject to the whims of the government”. Whether what has been seen recently in the yuan market meets that criterion will be for individual investors to ponder.
Prasad actually feels that “the notion that the [yuan] will one day rival the dollar for dominance as the global reserve currency is far-fetched”, even though “Chinese leaders are pursuing, no doubt in a slow and often meandering manner, financial liberalisation and limited market-oriented economic reforms”.
But policymakers in Beijing “have unequivocally repudiated political, legal, and institutional reforms”, Prasad wrote. “China’s government has, if anything, rolled back freedom of expression, the rule of law and the independence of key institutions from government interference.”
Those are strong words.
But even those who believe in the continuing global rise in the yuan’s prominence cannot easily deny that broader investor confidence in the use of the yuan is hardly going to be bolstered by evidence that Beijing seems perfectly willing to engineer currency moves as and when it likes.
Whatever Beijing’s reasons for engineering the moves in the yuan last week, wrong-footing investors, it all looked a bit heavy-handed.
While the yuan “has made remarkable progress in a relatively short period, it is far from assured that it will continue along the same impressive trajectory it has followed for the past few years”, the article said.
Potential investors in the yuan market need to have confidence that the playing field is level and that Beijing, as referee, is fair. When the referee starts abruptly moving the goalposts during the match, it does nothing to encourage wider confidence in the game.