The yuan: gaining currency

As China takes tentative steps towards lifting restrictions on the yuan, including engaging in a series of currency swaps with key trading partners, charts the renminbi’s increasing globalisation

Chinese Premier Wen Jiabao’s visit to the Middle East in January focused on securing oil and natural gas supplies for the world’s biggest export economy, yet tucked among the many announced agreements was a little noticed currency swap between China’s central bank and the Central Bank of the United Arab Emirates. The deal, which exchanges 35bn yuan (US$5.54bn) for DH20bn (US$5.44bn), was reached ostensibly to promote bilateral trade and investment. It also represents the latest step in Beijing’s long march towards internationalising its currency, the renminbi. China, which maintains one of the world’s most vigorously controlled currencies, has embarked on a path towards lifting restrictions that may allow the renminbi, or people’s money, to join the US dollar, euro and Japanese yen as a global reserve currency. Although the road ahead is littered with hurdles, economists and strategists agree that China is moving inexorably towards relaxing controls and broadening the use of its currency.

"Step-by-step process"

Basic convertibility, which will remove restrictions on capital flows across borders, may take place as early as in the next four years, says Huang Yiping, Chief Economist for emerging Asia at Barclays Capital. “Chinese officials have been diligently studying this issue and they see it in their interest to loosen restrictions,” Huang says.

China has embarked on a path towards lifting restrictions that may allow the renminbi to join the US dollar, euro and Japanese yen as a global reserve currency

Analysts aren’t expecting any watershed announcement. “It’s not like we will wake up one morning and there will be no more capital controls,” says Arthur Kroeber, Managing Director of GK Dragonomics, a Beijing-based economic research firm. “This will be a step-by-step process where economic imperatives will come up against political desires at every turn.”

Driving China’s currency policy are concerns about the country’s dependence on the US dollar in the post-Global Financial Crisis world. Three decades of export-driven growth, led by an undervalued currency, resulted in China amassing the world’s biggest foreign-exchange reserves, now totalling about US$3.2tn. More worrisome to policymakers, an estimated two-thirds of the country’s reserves are invested in US dollars and US dollar assets, such as long-term US Treasury debt, US agency debt and corporate bonds. “Chinese policymakers want to build an insurance policy in a US dollar dominated world,” says Kroeber of GK Dragonomics.

Hong Kong focus

China’s liberalisation efforts remain focused in Hong Kong. Starting in 2009, China gradually allowed local cities and provinces to settle trade with the Special Administrative Region using renminbi; the entire country was opened the following year. By the end of 2011, foreign trade in the city settled in yuan increased to nine per cent of the total, from less than one per cent a year earlier, primarily due to Chinese importers using renminbi to pay suppliers.

Meanwhile, regional and multinational firms, including Caterpillar and Volkswagen, have used Hong Kong’s capital markets to pool offshore renminbi through the issue of yuan-denominated, or so-called ‘dim-sum’ bonds. Last year, issuers sold 87 renminbi bonds worth more than RMB105bn (US$16.6bn) in the city, or three times the amount sold in 2010. China this year is embarking on the next phase of its reform, allowing Hong Kong-based fund managers to pool offshore renminbi to invest back in China’s domestic capital markets. China’s central bank is now swapping currency with other central banks; the trade with the UAE’s central bank was the 15th such deal, involving more than 1.3tn yuan (US$0.2tn). Moreover, central banks from Nigeria to Thailand will hold the renminbi as part of their own foreign-exchange reserves. In January, South Korea’s central bank said it gained approval to buy US$300m worth of Chinese equities and bonds to diversify its foreign-exchange reserves.

World market trading

China’s growing pace of reform has prompted financial centres from Singapore to London to express interest in developing offshore Chinese currency clearing and settlement centres of their own to complement Hong Kong. In the UAE, authorities are exploring opportunities available at the Dubai International Financial Centre (DIFC). Dubai is ideally positioned to fill the time-zone difference in world markets allowing for 24-hour global currency trading, and DIFC already houses the needed clearing and settlement system, said Dr Nasser Saidi, Chief Economist for the DIFC. Even the most aggressive analysts admit that China must undertake reforms before the renminbi can become a global reserve currency. First, the currency cannot be freely traded on the capital account. Second, China’s domestic securities markets remain underdeveloped, which makes it tricky for central banks and financial institutions to invest in yuan-denominated stocks and bonds. Arvind Subramanian, the Washington, DC-based economist at the Peterson Institute for International Economics who recently wrote that the yuan could become the “premier reserve currency” by early next decade, admits that China must first commercialise its banks, strengthen its market supervision, and allow the unobstructed trade of its currency.