Yuan steps on to world stage

Chinese currency is to be included in the IMF’s Special Drawing Rights basket of currencies. The decision comes as many countries, especially the UAE, have witnessed huge growth in yuan adoption.

The New York branch of Bank of China is set to start clearing facilities for the Chinese currency, marking a milestone in the yuan’s internationalisation. SeongJoon Cho / Bloomberg
Powered by automated translation

BEIJING // China last week announced it was establishing the first clearing bank for yuan or renminbi (RMB) in the United States.

This is seen as a milestone in the internationalisation of the Chinese currency just before the yuan is due to join a select club at the IMF on October 1.

From October 1, the yuan will be one of the five currencies used by the IMF for issuing Special Drawing Rights (SDR). SDR is a synthetic currency representing five currencies in the IMF basket, which is used for lending funds to countries that need it.

Around that time, the New York branch of Bank of China will start clearing facilities for the Chinese currency.

An important question is what would be the implications of these moves for other countries, including the UAE, who have extensive financial dealings in New York besides selling oil in huge quantities to China.

Data from the global member-owned cooperative and financial messaging services provider SWIFT’s latest RMB Tracker shows exceptional growth in yuan adoption in the UAE, witnessing a 210.8 per cent growth in payments value of the currency since August 2014, albeit from a low base. More than 80 per cent of the direct payments made between the UAE and China/Hong Kong in August 2016 were in yuan, representing one of the highest increases worldwide.

Data within the SWIFT report shows that the Europe, Middle East and Africa region is ranked as number two in yuan adoption after Asia-Pacific.

“RMB adoption in France, Switzerland and Germany is progressing slowly, while the UAE continues to show significant growth – we have seen impressive 44.6 per cent increase in payments value since August 2015,” says Alain Raes, the chief executive for Asia Pacific & EMEA at SWIFT.

“We expect this growth to continue in the UAE following the signing of a Memorandum of Understanding in December 2015 for the set-up of an additional clearing centre in the Middle East.

“This will enable even more corporates operating in the region to access RMB products, open RMB accounts and use the currency to make payments to both onshore and offshore counterparts,” he says.

Some analysts suspect China will insist on making some of its international payments in yuan while urging its business partners to reduce their reliance on the dollar. Beijing has already entered into 21 currency swaps with different countries, mostly in Asia, to encourage direct dealings instead of using the dollar.

Chinese officials have said a cleaning bank in New York would cut down the transaction costs for companies dealing with customers, suppliers and countries that have yuan reserves.

“This will facilitate all kinds of financial transactions in RMB, including issuing RMB-denominated debt,” Scott Kennedy, the deputy director of the Freeman chair in China studies at the Center for Strategic and International Studies, tells The National.

“RMB internationalisation requires deepening of RMB-based financial markets, and this is part of that process.”

“This is a long-term process that will take many years; these steps are just erecting the structure for this to occur,” he says.

An important issue is whether the rise of yuan including its place in IMF’s SDR basket will prove to be a challenge for the US dollar. Analysts are divided on the subject.

The weight of all currencies in the IMF basket will be eroded to make room for the Chinese currency, which will have 10.92 per cent share. The dollar will be least affected as its share will slide to 41.73 per cent from 41.9 per cent during the last IMF review in 2010, the IMF says on its website.

It adds that the euro will suffer most with its weight slipping to 30.93 per cent compared with 37.4 per cent at the 2010 Review. The share of pound sterling would slide to 8.09 per cent against 11.3 per cent earlier. The Japanese yen will also suffer a little as its contribution will come down to 8.33 per cent compared with 9.4 per cent at the 2010 Review, the IMF says.

"The establishment of an RMB clearing centre in the United States is an important milepost in the RMB's journey to becoming a major international currency," says Eswar Prasad, a senior professor at Cornell and author of an upcoming book, Gaining Currency: The Rise of the Renminbi.

Given China’s rising prominence in the world economy and in global trade, it is likely the yuan will become a more important currency for denomination and settlement of cross-border trade and financial transactions, he says.

“Having RMB clearing taking place in the world’s major international financial centres will be helpful in meeting this demand and, indeed, could have a catalytic effect in promoting the RMB’s use,” he says.

Chinese authorities have relaxed control over the currency to some extent to meet the strict IMF standards before it was accepted as an SDR currency after two rejections earlier. But the currency and its daily exchange rate is still controlled by the People’s Bank of China, the central bank, which is intervening in the market to keep the currency stable and fight bearish dealers.

Christopher Balding, a professor at HSBC school of business Peking University, has estimated China is spending US$50 billion a month to keep the currency stable. The yuan would fall 15 to 20 per cent the moment the government withdrew support to it, he says.

Others disagree

“I am sceptical that the RMB would fall so far, although it is clear that initially there would be a very large depreciation in the first couple of days after which I would expect the RMB to stabilise at a higher rate and perhaps only drop a total of say 5 to 7 per cent,” says Jacob Kirkegaard, a senior fellow at the Washington based Peterson Institute of International Economics.

“I don’t believe that the RMB today is dramatically overvalued.”

China’s battle to keep the yuan stable is part of its larger efforts to ensure that confidence in its economy, the world’s second-largest, is not eroded further. Foreign investments are down by nearly 40 per cent, according to independent estimates, and China is keen to check the slide.

“The government’s means to revive economic confidence are limited,” the Economic Intelligence Unit (EIU) says in a recent analysis. The country has seen continued deterioration in the services and manufacturing sectors, a sharp drop-off in private investment, and the ongoing build-up of the country’s debt stock resulting in structural weaknesses in the economy, it says.

The EIU says “poorly managed official attempts to shore up the stock market have highlighted concerns that the government’s promise to put a floor under economic growth might not be credible – as well as showing the shallow nature of the government’s commitment to allowing market forces to play a role in raising productivity”.

It also expresses worry that a weakening of the Chinese economy will have dangerous impact on world economic order.

“If China’s economy slows by more than we currently expect, it will further feed the ongoing global commodity price slump (especially in oil and, in particular, metals), with a hugely detrimental impact on those Latin American, Middle Eastern and sub-Saharan African states that had benefited from the earlier Chinese-driven boom in commodity prices.”

This is besides what would be the grave effect on western manufacturers and retailers who have become dependent on Chinese production, the EIU adds.


Follow The National's Business section on Twitter