Opinion

China’s yuan nowhere near cracking US dollar hegemony

For all Beijing's ambitions of cracking the hegemony of the US dollar in the face of Trump administration sanctions, the yuan still has a long way to go.

By: Date: October 30, 2020 Topic: Global economy and trade

The opinion post was originally published in Nikkei Asia Review.

The yuan is higher than it has been in more than two years, and foreigners are suddenly showing interest again in holding the Chinese currency.

Earlier in the decade, Beijing brought the yuan into the spotlight through an aggressive effort to take the currency overseas through swap agreements with foreign central banks and offshore bond issuances denominated in the currency.

This time, foreigners are coming to China to get yuan. Chinese assets stand out at a time interest rates in much of the world are at zero or below and many currencies are sagging. Beijing has meanwhile been making access easier for foreign buyers.

Yet for all Beijing’s ambitions of cracking the hegemony of the US dollar in the face of Trump administration sanctions, the yuan still has a long way to go. While this week’s meeting of the Communist Party Central Committee looks likely to take up the cause of yuan internationalization, the currency will not be taking the greenback’s place on the world scene any time soon.

Available data suggests that after plunging abruptly in 2015, international use of the yuan started to recover just last year. This year, foreigners have been snapping up yuan to put into domestic Chinese bonds and stocks, with holdings of such bonds alone rising by more than a quarter to 2.8 trillion yuan ($419.3 billion).

It goes without saying that the general weakness of the dollar since the COVID-19 pandemic began pounding the U.S. economy in March has been a blessing for the Chinese authorities’ attempts to attract inflows, boosted by the juicy interest rate differential between the two nations’ benchmark government bonds.

Looking deeper into current international use of the yuan, trade settlements in the Chinese currency have slightly picked up since last year, especially in services transactions.

Central bank reserves held in yuan have not been rising much though. Yuan loans and deposits held by overseas institutions also remain minimal.

Significantly, notwithstanding China’s growing exertion of economic, political and even cultural influence, the yuan has not yet become an official reference point for other Asian currencies or for private markets in general, with the exception of oil futures and a few other commodities.

What has been rising substantially is the value of international payments intermediated through the China International Payment System, a yuan-based alternative to the dollar-denominated SWIFT system based in Brussels. The volume of such payments processed through CIPS has been rising more slowly, indicating the network is mostly being used for high-value transactions.

What all of this seems to imply is that China is indeed fully aware of the risk of conducting most of its international trade and investment transactions in dollars and of holding most of its foreign assets in dollars. The way to reduce this dependence, beyond diversifying into use of other foreign currencies as has also been happening, is to boost the yuan.

Previously, international use of the yuan was outsourced to offshore financial centers, especially Hong Kong. This created a kind of dual market in yuan, one offshore and one onshore.

As the onshore market remained within China’s capital controls and allowed limited daily movements, traders could find arbitrage opportunities between the yuan’s varying valuation in the two markets.

This time around, the onshore yuan market is king, with Beijing keen to attract as much capital inflow as possible. Rather than keeping their yuan parked offshore, foreign investors are expected to enter the mainland even without full assurance taking out funds will be quicker or easier than in the past.

The notion is that Chinese capital markets are too big to be missed and that the growth differential between China and the rest of the world will ensure that the relative rate of return from yuan-based investing will remain positive.

Looking at the increase in portfolio inflows into the mainland, it is evident investors are buying into this story but maybe with a bit different reasoning.

For some international investors, the time is ripe for a carry trade of borrowing cheaply in dollars in the U.S. and then investing in yuan assets in China.

But any closing of the interest rate gap or renewed weakness in the yuan could change that picture dramatically. If the Chinese economy suddenly decelerates and the People’s Bank of China steps in by cutting rates or nudging the yuan lower, such foreign investors could take flight once again.

It would not be the first time. A sudden move by the PBOC in March 2014 to double the daily trading band of the Chinese currency spooked investors then, causing losses to those who had been counting on an ever-rising yuan.

A fully open capital account remains a key prerequisite. These days, 2030 seems to be China’s new target for achieving that, with the previous goal of 2020 fading from memory.

But the growing reach of U.S. sanctions and policy moves to drive financial decoupling from China could further set back Beijing’s efforts. Rather than taking the dollar’s place globally, the yuan might then emerge at best as a reserve currency within an ecosystem of linked nations, with the dollar remaining the reserve currency for the rest of the world.

That would be a win for yuan internationalization, but not a knock out.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read article
 

External Publication

European Parliament

Tailoring prudential policy to bank size: the application of proportionality in the US and euro area

In-depth analysis prepared for the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Alexander Lehmann and Nicolas Véron Topic: Banking and capital markets, European Parliament, Macroeconomic policy Date: October 14, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

Will ‘common prosperity’ address China’s inequality?

Why is China reviving this old mantra?

By: The Sound of Economics Topic: Global economy and trade Date: October 13, 2021
Read article More by this author
 

Opinion

European governance

The inconsistency in global strategic relations

All of this talk on strategic retrenchment and autonomy is the language of escalation, not of appeasement and collaboration.

By: Maria Demertzis Topic: European governance, Global economy and trade Date: October 13, 2021
Read article
 

Opinion

Xi’s pledge on financing coal plants overseas misses point

China’s domestic installation of coal-fired power plants continues at great pace.

By: Alicia García-Herrero and Simone Tagliapietra Topic: Global economy and trade, Green economy Date: October 7, 2021
Read article
 

Opinion

Will China use climate change as a bargaining chip?

Beijing shows signs of changing tactics ahead of the COP26 conference.

By: Alicia García-Herrero and Simone Tagliapietra Topic: Global economy and trade, Green economy Date: October 6, 2021
Read article More on this topic More by this author
 

Opinion

What Evergrande signals about China's economic future

Under Xi Jinping's new economic agenda 'common prosperity', China is cracking down on indebted real estate developers like Evergrande.

By: Alicia García-Herrero Topic: Global economy and trade Date: September 30, 2021
Read article More on this topic More by this author
 

Opinion

Europe doesn’t need a ‘Mega-Fab’

Europe should defend its existing dominance in equipment manufacturing for semiconductors and invest in chip design instead of luring high-end fabrication to its shores.

By: Niclas Poitiers Topic: Global economy and trade Date: September 22, 2021
Read article More on this topic More by this author
 

Blog Post

Opening up digital platforms and reducing anticompetitive risks

The current convergence in measures to open up digital platforms leaves a door open to some form of international coordination.

By: Georgios Petropoulos Topic: Digital economy and innovation Date: September 22, 2021
Read article More on this topic
 

External Publication

Investing in China: myths and realities

Concerns are real, but the country fares as well as peers at similar levels of development. Analysis published in fDi Intelligence.

By: Uri Dadush and Pauline Weil Topic: Global economy and trade Date: September 20, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

A Late Bloomer: where is China’s climate plan?

The world awaits China's concrete plan on carbon reduction, but the country is following its own pace.

By: The Sound of Economics Topic: Global economy and trade Date: September 8, 2021
Read article More on this topic More by this author
 

External Publication

What is behind China's Dual Circulation Strategy?

China's dual circulation strategy should not be dismissed as a buzzword: its implementation will entail major consequences.

By: Alicia García-Herrero Topic: Global economy and trade Date: September 7, 2021
Read article More by this author
 

Opinion

Why China should fear the EU's carbon border tax

Expect Beijing to soon start lobbying against the proposal.

By: Alicia García-Herrero Topic: Global economy and trade, Green economy Date: July 26, 2021
Load more posts