Chinese currency poised to become global heavyweight

The global importance of the Chinese yuan seems destined to rise, according to strategists and economists who believe that the flow in the currency will grow over the long term if Beijing continues to gradually open its financial system.

Background 

China was one of the first nations to create a currency that took the place of the barter system. In 1889, the Yuan was introduced as a silver coin derived from the Spanish dollar (peso). The modern Chinese yuan is also called the Renminbi which translates as the ‘people’s currency.’ It was first issued by the Chinese Communist Party’s People’s Bank of China in December 1948. Chinese yuan's globalisation journey generally started from piloting RMB settlement in cross-border trade in 2009 and picked up the pace in 2016 when the IMF included the yuan in the basket of currencies that make up the Special Drawing Right, an alternative reserve asset to the dollar.

China’s economic transformation kicked off 40 years ago when the Communist Party introduced a policy of reform and opening up to the outside world. That marked the initial step in what eventually took the country from a poor and agrarian nation to the industrial and technological giant of today that rivals the United States for global influence. The International Monetary Fund endorsed China's Yuan as a reserve currency two years ago — putting it in an elite club that includes the US Dollar and the British Pound.

Analysis

According to strategists and economists, the flow in the yuan currency will grow over the long term as China continues to gradually open its financial system and further pushes the use of the yuan internationally. However, authorities still keep a tight grip on the yuan allowing it to trade only narrowly even if movements have gradually widened. 

Chi Lo, senior economist for Greater China at BNP Paribas Asset Management in Hong Kong said that the yuan will become globally more important as China further allows foreign capital into the country through a selective financial opening and pursues its Belt and Road Initiative trade project, part of a policy to strengthen the country's international standing.

HSBC said in a report released that markets have been focused on the trade war between China and the United States as the main factor affecting the yuan. But, it said, China's opening of its financial markets is "probably the more important and enduring influence" on the currency.

Qinwei Wang, senior economist at Amundi Asset Management clearly stated that authorities want the yuan to play a bigger global role He cited currency swap arrangements at the People’s Bank of China can be seen as part of “China’s efforts to improve, increase the acceptance of the yuan, internationally.”

Global financial transfer system SWIFT said in its most recent monthly report on the yuan that it was the sixth most used currency in domestic and international payments value in October, just behind the Canadian dollar. Driven by the capital account flow and trade-related flows, China’s financial opening accelerated this year as portfolio investments reached an all-time high. With the foreign buying of Chinese stocks and bonds still far less than in many other markets, the banks see a significant shift coming as China opens the doors further. 

The government is positioning its currency for a broader role in global trade and finance. Hong Kong provides the ideal testing ground for putting the yuan in play through trade settlement transactions as well as yuan-denominated deposits and bonds. Some central banks have signed currency swaps with China’s central bank and begun adding yuan to their foreign exchange reserve portfolios. Thus, given its sheer economic heft, China is successfully promoting the yuan’s international use without fully opening up the capital account or allowing the currency to float.

Assessment 

Our assessment is that Beijing will need to ease its tight grip on currency and capital markets in order to build confidence that the country is moving towards liberalisation and transparency. Since the yuan is not a freely convertible currency, it must be seen as a currency determined by free-floating market forces rather than the decisions made behind closed doors.