Going Global with the Yuan

According to Dan Steinbock, the internationalisation of the renminbi is actually accelerating. The inclusion from the yuan in the IMF basket of reserves is now a matter of time.

On July 11, the People’s Bank of China (PBOC) adjusted the actual exchange rate of the Chinese language renminbi (RMB) against the US dollar to reflect market conditions. The net impact was a devaluation of 1.9% in accordance with the dollar.

The adjustment had been an effort to comply with the requirements the International Monetary Account (IMF) to include the yuan in the book currency basket. The move towards a more market-determined rate is what the IMF and the US Treasury, along with European financial authorities, have been asking for.

It aligns well with Beijing’utes effort to speed up the RMB internationalisation.

The Renminbi Goes International

Today, China is the world’s biggest exporter and the second-largest economy in the world in absolute terms. At the end of last year, the RMB moved into the fifth position in global payments, but still accounts barely over 2% of the international payments total. However, its explosive possible reflects its rise as a settlement currency for China’s global trade to 23% by early 2015.

Until the global financial crisis, the RMB had little exposure to worldwide markets because of government controls that prohibited almost all exports from the currency, or its use within international transactions. In the era of Xi Jinping and Li Keqiang, China is rebalancing toward consumption and development, and Beijing is fostering the RMB’s rise in worldwide finance.

After China joined the planet Trade Organization (WTO) in Mid 2001 and exports truly took off, the actual RMB has evolved as an international currency for paying for goods and services. Within this era – roughly, the 2000s before the global crisis – foreign multinationals invested in China, but Chinese foreign investment was minimal.

In the 2nd stage – the first half of the actual 2010s – China consolidated its part as the world’s trading engine. As Chinese capital is actually increasingly going out, leading Chinese brands, from ICT (Lenovo, Huawei, Tencent, Alibaba, China Cellular) to financial institutions (ICBC, China Construction Bank, Agricultural Bank associated with China, Bank of The far east) to oil and gas (Sinopec, PetroChina) are becoming familiar abroad.  Further, the RMB’s role is expanding as a currency for worldwide investment.  Concurrently, the number of Chinese vacationing overseas has soared in order to 117 million.

In the third stage, the actual RMB seeks to achieve a new status as a reserve currency with sovereign governments. That is where we’re today. The transition will not occur without friction. All major international currencies – the US dollar, Euro, British sterling as well as Japanese yen – have experienced their share of growth discomfort.

The summer turmoil in the Chinese equity markets reflects these types of transitional challenges. In early The year 2013, I predicted the impending boom in the Chinese markets. Within mid-June, that boom resulted in a serious correction. Despite volatility, the potential of Chinese market prevails.

RMB Monetary Channels

The internationalisation of the RMB also benefits from the actual steady expansion of new RMB cleaning banks, which provide direct access to RMB liquidity in China, while contributing to the expansion of offshore RMB.

The launch of the Shanghai-Hong Kong Stock Connect – the cross-boundary investment channel which connects the two markets – has boosted the growth of trading volumes, along with Shanghai’s Free Trade Zone (FTZ), which is paving way to new FTZ reforms in other cities.

Despite initial specialized challenges and the Chinese stock market correction, the China Worldwide Payment System (CIPS) expects a fall introduction. Scaled down, its use will be for cross-border yuan trade deals.

There are almost an estimated $500 billion of RMB bilateral currency swaps – agreements between two nations to ensure access to each other’utes currency if needed – in China and more than 30 countries.

These efforts are complemented by the launch from the massive “One Belt, 1 Road” regional initiatives in China’utes regional proximity and internationally.

After years of hollow reform promises by the G7 nations, China can also be taking a more proactive role in global finance, with the BRICS New Development Bank and also the Asian Infrastructure Investment Bank (AIIB). Despite initial US resistance, the AIIB took off dramatically last spring, especially after the UK joined the bank, which provided the way for other EU economies.

Emergence of RMB Commodity Trading

Intriguingly, the dominant role of the dollar in global commodity pricing evolved in the 1970s once the US dominance began to deteriorate. When America became an energy importer, it grew more dependent on the leading oil producers. As the Middle East’s oil economies opted for the dollar because payment currency, the petrodollar era came to rest on financial and strategic relations (oil for US dollars and military aid).

Until recently, these arrangements have enhanced US geopolitical might in the Middle East, including Washington’s ties with Saudi Arabia. However, as the US shale revolution became popular and China’s role as the largest buyer has steadily increased in the region, the old status quo is gradually eroding.

While the actual dollar remains the dominant forex for most commodities, China’s part in international commodity trade has increased dramatically. It is the biggest consumer of iron ore, zinc oxide, lead and copper. In the coming years, increasing share of commodity trade is likely to cost in RMB, as evidenced through the emergence of RMB-denominated contracts upon exchanges in Chinese cities.

As the world’s largest customer and producer of precious metal, China also hopes to lead to determining gold prices. Just three years ago, Hong Kong Exchanges and Clearing bought the London Metals Exchange, while Shanghai is going to launch an RMB-denominated gold-index.

In the future, item prices are likely to gravitate towards the RMB and other large emerging-economy currencies.

The $1 Trillion Dollar Reserve-currency Decision

The RMB’s route to a major reserve currency includes economic and geopolitical challenges. In the past, the value of the currency has caused major debates. These ended in May, when the IMF reported that the RMB was valued, while advocating Beijing to develop a flying exchange rate within 3 years.

Nevertheless, US Congress and the Treasury still argue that the RMB should be buying and selling at higher levels from the dollar, due to China’s industry surplus, the plunge associated with oil prices, and rising Chinese productivity. These quarrels are no longer persuasive, however.

The trigger for the fall of oil prices was the US shale trend and the Middle East’s overcapacity. The US has had regional trade deficits for decades with East Asia (first with Japan, then with the Asian tiger financial systems, and more recently with China). In addition, in the decade just before recent turmoil, the RMB appreciated 30% against the dollar.

According to China’s central bank, foreign central banks held over $110 million in RMB-denominated assets in April. Despite rapid RMB expansion, the actual starting-point is low. In 2014, complete foreign exchange reserves amounted to more than $6 trillion.

Today, the RMB satisfies most basic preconditions of a reserve forex. China has become the second-largest economy on the planet. Second, the RMB has evolved within an environment of low inflation, small budget deficits and stable growth. Third, an upswing of the RMB as major book currency relies on strong institutional support. The fourth condition requires deep, open and well-regulated capital marketplaces, which is why China is speeding up financial reforms. In April, Beijing pledged that the capital account liberalisation would occur after the year.

China had hoped the RMB could be in the IMF’s container by January 1, 2016. Nevertheless, in early August, they requested the IMF to delay its RMB inclusion until September 2016. The timing matters. Before the summer, Standard Chartered and AXA Investment Managers estimated that at least $1 trillion of worldwide reserves would switch in to Chinese assets when the IMF encourages the RMB as a reserve forex.

Toward Multiple-currency Reserves

In nominal terms, the size of the Chinese economy is likely to exceed those of the US in the 2020s. However, dimensions are not everything. While the US economy surpassed that of Britain in the late 19^th century, sterling remained the preferred currency in international commerce and the dominant device for investments and sovereign reserves well into the early 20^th hundred years.

Things began to change after The first world war, when the dollar surged within trade finance. As traders began to move from sterling to dollar and central banks started to expand their dollar reserves, the stage was set for a transition.

In the past half a decade, the RMB has achieved dramatic progress in commodities, trade, investment and sovereign reserves. It is increasingly central to item trading. The RMB’s catch-up using the Japanese yen and the British pound will take longer – and even longer, to gain parity using the dollar and the euro, which still represent 45% and 28% associated with international payments, respectively.

Nevertheless, the actual RMB’s role as a main reserve currency is now a matter of time. In the short-term, the changeover means increasing market unpredictability. In the medium-term, it has potential to support China’s rebalancing and thus growth potential customers globally.

The RMB will be the first emerging-economy currency that will join the sovereign supplies. In that role, it will lead way to other major emerging-economy currencies in the future.

The Internationalisation of the Renminbi is republished along with permission from The Difference Group