“US-China tensions risk spreading beyond the realms of trade, investment, and technology in the future, and in turn could exert pressure on the international development of the yuan,” said the report from the 769-member China Banking Association, which was established in 2000 to promote the development of the banking industry.

“Since 2020, the global economy has been affected by the coronavirus epidemic and has fallen into a severe recession, global financial markets were turbulent and trade protectionism has been on the rise. Under the influence of the epidemic, the process of yuan internationalisation is facing various internal and external challenges.”

Bernard Aw, Asia-Pacific economist at credit insurance firm Coface, said depreciation pressure on the yuan could result from the US Federal Reserves looking to normalise monetary policy by reducing quantitative easing and raising interest rates.

“The current Chinese recovery remains unstable and uneven, according to the meeting, with current economic challenges compounded by the evolving global Covid-19 trajectory and an increasingly complex and grave external environment.”

Yuan internationalisation needs ‘persistent, strong foreign demand’

Even though China’s total gross domestic product accounted for nearly 17 per cent of the world’s total in 2020, the yuan’s share of total international settlements and global exchange reserves remains modest at around 2 per cent, well behind the US dollar, the euro and the Japanese yen.

History shows that the internationalisation of the British pound and the US dollar were market-driven, natural processes that accompanied the growth of their own political and economic power, according to a report by Bank of China (Hong Kong) chief economist E Zhihuan and research analyst Ding Meng.

In the 18th century, Britain relied on the Industrial Revolution to establish a strong industrial system, importing raw materials from foreign countries while exporting industrial products to the rest of the world.

By the 19th century, Britain was the most economically powerful country in the world based on the trust in its economy and ability to exchange the pound for gold. All countries were willing to use the British pound for international settlements, and the rise of the currency gradually replaced the Spanish silver dollar as the main international currency.

Similarly, the internationalisation of the US dollar benefited from the United States’ gradual replacement of Britain as the world‘s largest economy at the end of the 19th century.

The Bretton Woods International Conference held in 1944 marked the official formation of an international monetary system dominated by the US dollar after World War II. When the Bretton Woods system collapsed in the early 1970s, the US dollar became the main international credit currency.

Why is the US dollar-yuan exchange rate important?

China’s internationalisation model has deep-seated problems, preventing the smooth circulation of the yuan, said Zhang Ming, director of the China Chief Economist Forum and former chief economist of Ping An Securities.

The network and services provided by Chinese commercial banks in the belt and road region are still inferior to those of US and European banks. Compared to US dollar or local currencies, customers have limited options in investment products denominated in yuan, invariably affecting the willingness to increase their yuan holdings, analysts said.

 The offshore financial market mainly provides investment and financing channels for yuan funds flowing out of China, but there is no effective way for offshore yuan assets to return because the domestic capital account is still not fully open.

Foreign investors’ participation in the domestic financial market and foreign-owned domestic financial institutions are still subject to quota and restrictions for domestic investments, Zhang added.