Coronavirus: China refuses to be beholden to US dollar even as pandemic creates shortage
- A shortage of US dollars created by increased demand during the coronavirus pandemic threatens Chinese companies’ ability to raise new funds to pay off existing debts
- The US Federal Reserve has expanded its US dollar swap lines to 14 central banks, but not the People’s Bank of China
China is reluctant to project an image to the international community that it needs the United States to provide it with easier access to US dollars, even though the coronavirus pandemic has created a shortage of the currency needed by non-American companies to pay their bills, analysts said.
The result is that if a US dollar shortage in the global financial system continues, and there is no reciprocal currency arrangement – a so-called swap line – between the Chinese and US central banks, it would raise the prospect that China could have to tap into its massive foreign exchange reserves to help pay the nation’s foreign bills.
Beijing does not want to be beholden to the US and receive an infusion of US dollars that would look like a US bailout and which could come with implicit political strings attached, according to Michael Every, global strategist at Rabobank.
In turn, the US does not want to be seen giving aid to save Chinese firms, especially since the White House openly describes China as a “strategic rival” and is pushing firms to move production back to the US, Every said.
To ensure US dollars are made available on a massive scale to foreign central banks, the US Federal Reserve expanded its US dollar swap lines to 14 central banks from five previously, allowing them to exchange their local currency for US dollars for a set period. It also announced a new temporary facility that allows any foreign central bank to exchange their US Treasury securities holdings for US dollars.
All three Asian central banks with the swap lines – the Bank of Korea, the Monetary Authority of Singapore and the Bank of Japan – have started drawing down from the lines to offer US dollar funds to their domestic banks.
But China, along with Russia and Turkey, were not included in the coordinated central bank swap line enhancements.
During the global financial crisis in 2008, China enacted a 4 trillion yuan stimulus package, joining the US in coordinated large-scale fiscal stimulus designed to save the world economy. But China’s measures this time round, including lowering of banks’ reserve requirement ratios and the provision of additional liquidity to the market, have been much more restrained.
Other central banks, such as those in China, Hong Kong and Russia could also benefit, but we doubt they would tap Fed swap lines given their political backdrops
The People’s Bank of China would probably refuse to tap the US Federal Reserve lines since China still has the world’s largest foreign exchange reserves that can help in an emergency situation, analysts said.
“Other central banks, such as those in China, Hong Kong and Russia could also benefit, but we doubt they would tap Fed swap lines given their political backdrops,” said Steve Englander, global head of G10 currency research and North America macro strategy at Standard Chartered Bank.
The US measures have helped to calm global financial markets, which are still reeling from the economic damage being done by the Covid-19 pandemic, but the burden of US dollar funding continues. Chinese companies have been borrowing US dollar debt for their overseas expansion as well as bringing proceeds back to China to convert into yuan for domestic purposes.
Recently, an acquisition of land use rights in Henan province by a Chinese company was financed with US dollar debt swapped into yuan funds; a property development in the Yangtze River Delta region was financed with investments in US dollars converted into yuan; and the expansion and renovation of several car showrooms in Wuhan were funded with US dollars.
The shortage created by the sharp rise in demand for US dollars during the pandemic is expected to force a protracted contraction in US dollar bond issuance by riskier Chinese firms, who face a tidal wave of US$30 billion in bonds that will mature in the second half of the year, said Chang Wei-liang, currency and credit macro strategist at DBS Bank.
There could be increased yuan-denominated issuance in the domestic Chinese bond market, as well as increased bank lending to make up for the decline in US dollar financing, Chang said.
Reflecting the market stress, Chinese high-yield US dollar bond issuance plunged 70 per cent to US$2.12 billion in March compared to February, according to credit data provider Debtwire.
The challenge lies more in the ability to reach beyond the banking sector and to send these funds through to needy households and corporate borrowers, said Michael Howell, cross-asset liquidity strategist at CrossBorder Capital in a note published by online research firm SmartKarma.
China may wish to reduce the reliance on the US dollar, replacing it with the yuan by boosting the yuan’s role in the global financial system. In the past decade, it has signed its own currency swap deals with more than 30 central banks to support the settlement of yuan, as well as taken measures to gradually open up its capital markets to foreign investors.
This means it is difficult to see an end to US dollar dominance underpinning global financing conditions in the absence of a more rapid progress of yuan internationalisation, said Charles Dumas, chief economist at TS Lombard.
China is starting to realise how heavy and transformative the burden of a true reserve currency status is
“China may dislike dollar hegemony, but it is not prepared to allow the liberalisation of capital flows needed for the yuan to achieve true reserve currency status,” Dumas said.
The yuan’s share of global transactions was only 2.1 per cent in February. In contrast, the share of transactions was 41.5 per cent for the US dollar and 32.6 per cent for the euro, according to data from bank messaging network SWIFT.
The coronavirus pandemic underscores the addiction of global firms to US dollar liquidity, cementing the US’ status as the world’s preferred lender, Rabobank’s Every said.
“China is starting to realise how heavy and transformative the burden of a true reserve currency status is,” Every said. “To replace the US dollar, you need to act like the US, and that implies not having control of one’s exchange rate.”
