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Yuan Internationalization

SpeeDing up again

The internationalization of the Chinese yuan seems to be gaining momentum after slowing down for nearly two years.

By NewsChina Updated Aug.1

Editorial note: 
In 2009, China officially launched a strategy of broadening the worldwide use of the yuan, the Chinese currency, also called the renminbi (RMB). The target was to make the yuan widely used in trade settlement and financial transactions and as an official reserve currency on the international markets, just like the US dollar, the euro and the British pound. The use of the yuan in China’s foreign trade settlement made rapid progress, as did the establishment of offshore yuan trading centers in major international financial hubs in Asia and Europe within a few years of the campaign, notably in Hong Kong and London. 
But the campaign lost momentum in the second half of 2015, due to concerns over the drastic depreciation of the yuan at irregular intervals. Even the October 2016 milestone inclusion of the yuan into the Special Drawing Rights basket, the currencies in which the official reserve assets held by members of the International Monetary Fund are denominated, didn’t return the process to the fast lane. In the following months, China had to tighten capital controls and burn through a significant portion of its official foreign exchange reserves to defend the yuan’s value.  
Recently there have been signs that China hopes to speed up the process again as the pressures of capital flight have been eased by the country’s growth rebound and capital controls. At a meeting at the end of March, Yi Gang, deputy governor of the People’s Bank of China, China’s central bank, stressed that China’s stable growth prospects and the market’s desire for an international yuan,“the most important foundations and pillars for the yuan’s internationalization,” remained intact. In April and May, the official average central parity price of the yuan against the US dollar rebounded. The speed of the yuan’s appreciation accelerated quickly at the end of May, largely due to a decision by the People’s Bank of China to adjust the formulas used to calculate the allowable swings in the yuan. In mid-May, China declared it would further open its inter-bank bond market to overseas investors.  
In the long term, one of the major driving forces toward internalization of the yuan is the implementation of the Belt and Road Initiative, a cross-continental program of trade and infrastructure being promoted by China. Tu Yonghong, deputy director of the International Monetary Institute of Renmin University of China, explains why steps on the ground towards realizing the Belt and Road vision will provide fresh momentum for the yuan’s internationalization, even though it may take at least one or two generations.

At a time when economic globalization is encountering headwinds, the Belt and Road Initiative offers important global public goods. The option of a new international currency – China’s yuan – is one of these. A huge amount of long-term funding is needed for Belt and Road projects, which are expected to push forward Asian economic cooperation and benefit the whole world.

The inclusion of the yuan into the Special Drawing Rights basket has made it more possible for countries along the route of the Belt and Road to access the yuan-denominated facilities and services of China’s financial institutions.  

China has already made remarkable steps in building institutions. No fewer than 77 economies around the world have joined the Asian Infrastructure Investment Bank (AIIB), which was created and mainly funded by China. This can attract more international capital into Belt and Road-linked projects, which in turn paves the way for new international financial cooperation, better infrastructure connectivity and more trade exchanges. All of this will make the AIIB a new supplier of public goods for global finance.  

Implementing the Belt and Road Initiative is likely to bring three breakthroughs in the internationalization of the yuan. Firstly, the yuan can be used in the settlement of energy and commodity transactions. As the experiences of the UK, the US and Japan have proved, changes in the global trade structure have always affected the major currencies involved in the trade.

Then the newly-gained power of a currency spreads to global finance, and eventually changes the international currency landscape.  

China became the world’s largest trading nation in 2013, and the biggest trading partner for most of the Belt and Road countries. More than 70 percent of China’s commodity imports are from Belt and Road countries. As the yuan has joined the SDR basket and China enjoys robust economic growth prospects in the long term, exporters in these countries want to maintain their market share in China, and both those exporters and Chinese importers alike have strong incentives to use the yuan to reduce the foreign exchange risks in production costs.  

More yuan-denominated trade is probably more attractive in the global oil market than in other areas. The US used to be the world’s biggest oil importer and thus had a big say in the global oil trade. The shale gas boom and the drilling of deep water oil in the Gulf of Mexico have turned the US into an oil exporter. [The US Congress lifted a 40-year ban on US oil exports at the end of 2015. Annual crude oil production has exceeded imports in the US since 2014, according to the US Energy Information Administration.] Today, China is the world’s biggest importer of oil, making it strongly motivated to support yuan-denominated oil imports from Belt and Road countries. 

Direct investment into and financing for Belt and Road projects can also expand the use of the yuan. China’s strong investment in infrastructure and industrial parks provides a model that many Belt and Road countries are eager to emulate to help with their own economic take-offs.

Partly thanks to the business opportunities brought about by the Belt and Road initiative, Chinese companies’ overseas investments have leapt forward over the past few years. In projects that are mainly funded by loans and equity investment from China, especially infrastructure and industrial park projects, the equipment, technology and services are also usually provided by Chinese companies (see Breaking the Mold: NewsChina, July 2017). Using the yuan in these deals makes the settlement easier. As a result, the yuan’s position in cross-border financial and trade transactions will be reinforced.  

The Belt and Road Initiative also offers an opportunity to build a better offshore market for the yuan. After a pool of the yuan-denominated capital is formed in the Belt and Road markets, holders and investors of the yuan will need a developed offshore yuan market where holders and investors can use the currency freely and build up yuan-denominated wealth. Most international financial deals take place on the offshore markets. International institutional investors and multinationals like to take advantage of such markets, which are less regulated by their home and host governments, focus on wholesaling services, function efficiently and provide a narrow net interest spread between lending and borrowing rates. The US dollar, the euro, the British pound and the Japanese yen are all traded heavily on offshore markets.  

The demand for the yuan will increase as trade, investment and financing along the Belt and Road routes is getting more active. In the meantime, Chinese financial institutions will build a stronger presence there. The growth of both demand and supply for the yuan will facilitate the better development of offshore markets.  

The Belt and Road Forum for International Cooperation that concluded in mid-May 2017 has led to plans for a properly functioning supply of capital. China will provide more than US$132 billion in equivalent yuan capital for Belt and Road projects through China’s policy banks, the Silk Road Fund and commercial banks. The AIIB will join hands with other multilateral financial institutions and development banks of Belt and Road countries to build a financing network. China has also declared it will set up special investment funds for key projects in some countries, such as Russia. Fiscal authorities and export insurance organizations in Belt and Road countries are also expected to work closely together.  

These efforts will lay a solid foundation for infrastructure connectivity and trade exchanges as part of the implementation of the Belt and Road Initiative. More importantly, the aim of the ongoing reforms of the international monetary system since the 2007 global financial crisis is to secure the stability of global finance. This calls for a more diversified and balanced global monetary system. The yuan has a big role to play in both funding for Belt and Road projects and international monetary reform. In addition, those countries have huge demand for Chinese capital and closer trade relations with China, and are susceptible to the spillover effect of the yuan’s exchange rate fluctuation and China’s monetary policy. China is economically and financially in a better position and ready to provide public goods for the steady growth of Belt and Road countries and a better international monetary system.  

But there are several things that China needs to do before its currency can be widely used by Belt and Road countries in their trade settlement, direct outward investment and offshore borrowing.  

Firstly, China needs to have futures markets strong enough for yuan-denominated commodities and financial products to be properly priced and favored by investors as tools for hedging market risks. In this way, the yuan will be more accessible at a lower cost on the international market.  

Secondly, the yuan has to be the major currency in the capital supply for Belt and Road projects. This can be done through the AIIB, the Silk Road Fund and China’s policy banks, including the China Development Bank. Their support for Belt and Road Initiative projects will encourage their partners, including financial institutions and investors from other countries, to shift from US dollar dominance to a US dollar-Chinese yuan dual track in their operations, and then further move toward yuan dominance.  

Thirdly, e-commerce business can help boost the use of the yuan. China leads the world in terms of the size of its online shopping market and technology. Chinese communication and Internet companies can contribute to the information and logistics of infrastructure construction along the Belt and Road. This has to combine with software services in information security, finance and legal services. All these efforts can combine to provide favorable conditions for using the yuan in the pricing and settlement of trade via cross-border e-commerce.