The Chinese Yuan: The next global currency?

China’s desire for the yuan to become an alternative to the U.S dollar in the future seems eminent. With the decline of dominate reserve currencies, the major contribution in global economic growth of China and the latest allowance of Pakistan on using Chinese yuan for bilateral trade, the yuan has a great opportunity to be a serious candidate.

 

Chinese economy and its impact on the Global economy

The second largest economy in the world has remained strong in 2017 with the GDP growth of 6.8 percent, exceeding market expectations. The recovery of global economy has been an important factor supporting economic activities of China to bounce back from its slowest rate since 2012.

 

Figure 1: China GDP growth (Wildau, 2017)

 

Thanks to favourable global financial conditions, greater domestic market confidence, implementation of capital controls and new measures to slow down the pace of leverage in the economy, capital outflows and credit growth moderated. This means higher levels of investment spending, lower financial risks and leverage are expected from the economy.

However, the moderation is still undeniable. Firstly, moving from a manufacturing and export-driven to a service and domestically-driven economy results in a decline in exports up to 20 percent- the biggest reason of China’s latest slump. Moreover, the aggressive cut of the borrowing cost triggered unsustainable debt services to dominate against the spending in the real economy. Last but not least, the ambition of transition to a developed economy also means the economic growth rate cannot easily jump 10 percent per year.

In terms of implications on the global economy, the slowdown does not stop China from being a crucial role of the world’s economic activity. According to forecasts by the World Bank, China still holds the largest contribution to the global economic growth of 35 percent. Even though the U.S follows as the second biggest contributors of 17.9%, the projection is uncertain due to the new US administration. So, no matter how moderate its economy is, the China-centric global growth dynamic remains persistent.

 

Figure 2: % of est. global growth (2017-2019) in real GDP (Desjardins, 2017)

 

The yuan’s performance

Under those circumstances, it is likely for the Yuan to become a new global currency especially when the U.S has been left behind in the influence competition of the global economic growth.

The Chinese Yuan created in 1949 had its foreign exchange rate regime change over time. In 1994, the currency was first pegged to the U.S dollar, then was allowed to float freely in 2005. After the GFC, the yuan was again pegged to the U.S, which is an effort of the government to stabilize the economy.

As of 2015, an additional reform program on the yuan introduced by central bank of China helped the currency join the Special Drawing Rights Basket (SDR) – the elite club of the International Monetary Fund (IMF) reserve currencies. The event is an important milestone of the renminbi as it means that China is expanding its role in global trade and substantially increasing the international use and trading of the currency.

Since Trump’s presidency started, the accusation of currency manipulation has been prompted towards Chinese government. By letting the renminbi float in August 2015, the yuan exchange rate reduced three times in just one week. Furthermore, buying American bonds which makes the dollar appreciate and keep the yuan low makes such statement seem true.

Nevertheless, President Trump is right, but late. Since 2005, the yuan is no longer undervalued. In fact, the Renminbi appreciated by 5.0 percent against the US dollar over January-November 2017.

 

Figure 3: Value of the renminbi (Porter, 2017)

Actually, China spent $1 trillion of foreign-exchange reserves to defend its currency in early 2017. China now owns almost a third of the U.S debt, holding cheaper currency means less beneficial when exchanging the U.S debt from the dollar into the yuan. The cheap yuan also leads to capital flight trend out of China as investors would not happy to hold cheap money, which is unfavourable to the government.

 

Road to become a truly global currency

By its influence on the world economy, China is a potential candidate to become the next global currency. It is obvious that the yuan is not in favour of being devalued or the government does not seem to keep it artificially low. In addition to that, major currencies like the dollar, euro, Japanese yen and the UK sterling have been weakened in recent years while the Canadian dollar, Australian dollar and Swiss franc are too small to absorb the world’s great glut of monetary liquidity.

By the end of 2013, the yuan had become the second most used trade financing currency and ranked 9th most used currency for payments globally. According to the IMF, the renminbi’s inclusion in the SDR baskets also means that it is “freely usable” – widely traded in the principal exchange markets and used to make payment for international transactions.

After being the target of Trump’s first Tweet in 2018, Pakistan replied by allowing Chinese Yuan to be an approved foreign currency for denominating foreign currency transactions in Pakistan. “ The United States has foolishly given Pakistan more than 33 billion dollars in aid over the last 15 years, and they have given us nothing but lies & deceit, thinking of our leaders as fools”, President Trump tweeted. Dumping the Dollar for Yuan is clearly not only an action to answer back to the U.S government, but is also a recognition of Chinese global economic influence.

Conclusion

A greater role for the yuan would require Chinese government more effort to liberalize its financial policies. Measures on decreasing exchange-rate intervention, relaxing restrictions on capital flow and liberalizing interest rates are expected to be enforced.

Criteria for a true reserve currency status such as convertibility, credibility and confidence are challenging for China to meet. If the yuan has those characteristics backed by transparent and credible policies, the road to become the next global currency is not impossible.

 

This content has been written and published by KOSEC – Kodari Securities.

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