Beijing’s plan to internationalize the yuan is well on course while the yen’s slippage means less liquidity for Japan’s capital markets
https://asiatimes.com-by William Pesek
The yen is falling while the yuan is rising. Image: Agencies / Twitter
TOKYO – It turns out growing 8.1% wasn’t the most important 2021 milestone for China’s economy. That honor goes to Beijing’s currency topping the yen to become the fourth-most used for cross-border payments.
In a year in which Covid-19 disruptions savaged gross domestic product (GDP) around the globe, President Xi Jinping’s economy managed to advance at the fastest rate in a decade. Yet the real pay-off for his Communist Party is that its five-year-plus plan to internationalize the yuan paid serious dividends.
According to the Society for Worldwide Interbank Financial Telecommunications, or SWIFT, China’s currency accounted for roughly 2.7% of the market. Granted, that’s a fraction of the US dollar’s 41% share.
But officials in Tokyo can’t be happy to see the yen’s share dwindle to 2.58%. After all, the yen’s wide use in global finance and trade is one of Japan’s key claims to global relevance.
True, the yuan previously grabbed the No 4 spot briefly in August 2015, but there’s every reason to think this time is for real. And with this growing status comes new responsibility.
Is Xi’s economy ready to play a stakeholder role in the global system, not only that of a shareholder, at the outset of 2022?
Expanding the channels
Since 2016, Xi Jinping’s government has been setting the stage for this moment.
Efforts to raise the yuan’s profile first bore fruit in 2016 when then-People’s Bank of China governor Zhou Xiaochuan secured a place for the yuan in the International Monetary Fund’s (IMF) special drawing-rights program.
It marked the yuan’s inclusion in the IMF’s club of reserve currencies, joining the dollar, euro, yen and pound.
In the years since, Xi’s team increased and broadened the channels for foreign investors to access mainland stock and bond markets. Chinese shares, for example, were added to the MSCI Index, while government bonds were included in the FTSE Russell benchmark. That, and moves to increase financial transparency, increased global demand for the yuan.
The growth in yuan usage over the last decade is unmistakable. In December, international funds increased holdings of Chinese government debt to a record. It capped off a decade-long increase in demand for the yuan.
In October 2010, the yuan ranked 35th, says SWIFT, which handles cross-border transactions for more than 11,000 financial institutions in 200 countries. Now Beijing is showing Tokyo what the future holds.
The less global companies, governments and investors utilize the yen, the less liquidity there will be in Japan’s capital markets. That could lead to less investment in yen assets, a dynamic that could reduce Nikkei 225 and Topix index valuations and boost long-term debt yields.
It also means less transacting with Japanese banks, lost global status in the halls of global financial power and, eventually, less influence for Japan in institutions like the IMF.
As the yuan’s use increases, and more capital flocks to Chinese equity and bond markets, the mainland is becoming more dominant in global finance.
Nicolas Aguzin, CEO at Hong Kong Exchanges and Clearing Limited, says rapid growth in the second-biggest economy and reforms are propelling a once-in-a-generation “big bang of finance.”
The bottom line: “I feel pretty confident that we are going to see China’s onshore capital markets continue to expand in breadth and depth.”
In many ways, though, the hard part is only just beginning, says Michael Pettis, who teaches finance at Peking University.
“Obviously, it’s not a surprise that larger economies tend to have the most widely traded currencies. In order to gauge their usefulness and ease, however, I like to rank currencies adjusted by their share of global GDP.”
Data limitations make that difficult. Yet, Pettis argues, using GDP as a benchmark “to normalize rank will return results that are sometimes surprising.”
He reckons that among the top 20 currencies, the Hong Kong dollar comes in first, followed by Singapore’s dollar, the euro, pound and then the US dollar. He ranks the Swiss franc 12th, the Canadian dollar 13th, the yen 17th, Mexico’s peso 18th and the yuan a lowly 19th.
Karl Schamotta, chief strategist at payments giant Corpay, thinks “the pace of internationalization looks less impressive once you remove trade with Hong Kong from the total volume.”
Others, however, disagree. Christopher Twomey, a China expert at the US Naval Postgraduate School, reckons deals related to China’s Belt and Road Initiative may “account for a good bit of growth” in yuan use.
Yet the steady increase in yuan transactions looks here to stay – and could be a global game-changer. In short: Shanghai and Beijing will steadily become the places to go for global borrowing and investment deals, not Tokyo.
A muscle-bound yuan
Xi’s reform team is very much on the clock as the yuan moves closer to center stage just as the dollar looks set to pull in more capital as Washington pivots toward monetary austerity.
The yuan “has enjoyed a strong appreciation cycle since China came out of Covid lockdown in early 2020: the currency is up 9.9% against the dollar and 11.5% on a trade-weighted basis since the beginning of June 2020,” says Wie He at Gavekal Research.
“That appreciation cycle is probably coming to an end soon, as China’s export growth is likely to cool off and the People’s Bank of China is easing policy while the US Federal Reserve tightens.”
He notes that the last two appreciation cycles for the renminbi, over 2011 to 2014, and over 2017 to 2018, were followed by significant declines against the dollar. “The end of this appreciation cycle should be less dramatic due to important changes in how China’s international investment position evolved,” He says.
“This time around,” He adds, “Chinese banks and companies have built up lots of easily liquidated foreign-exchange assets, sales of which can dampen any decline in the renminbi. While the renminbi is still likely to fall in coming months, the structure of China’s foreign assets and liabilities points to only mild depreciation pressures.”
Fitch Analytics argues that with the PBOC cutting interest rates and the Fed tapering, “the yuan remains overvalued which will likely further drive imports and discourage exports over the coming months, putting depreciatory pressure on the unit.”
The more important dynamic is how Xi’s team builds international trust in the yuan. That credibility will be vital as China spreads its wings in global trade and finance, but some say that is going to prove problematic.
Xi’s “party grounds its legitimacy in maintaining high economic growth,” says economist Benn Steil at the Council on Foreign Relations. “To deliver on its growth targets, it has for decades stoked real-estate speculation and unproductive corporate borrowing.
“The result is continuously rising levels of leverage across China’s economy. Beijing knows its trajectory is ultimately unsustainable. But history suggests it won’t change course anytime soon.”
The only way to pull off the transition, Steil says, is to ensure global central banks, trading companies and investors have solid confidence in the yuan. A key element is to increase trust in the policy decisions made at the highest levels of Chinese leadership.
Here, Team Xi has some serious work to do.
Beijing’s heavy-handed crackdowns on tech, education, entertainment and other sectors generated high levels of turmoil in capital markets. His anti-leverage policies played a direct role in last year’s defaults by China Evergrande Group and other major property developers.
Now there’s growing concern about Xi’s “zero Covid” absolutism as the wildly transmissible Omicron variant spreads. Concerns that the policy will cause a Chinese slowdown, says strategist Greg Anderson at BMO Capital Markets, is – oddly – undermining currencies that would normally benefit from rising commodity prices.
The PBOC will do what it can, says analyst Nicholas Chen at advisory CreditSights.
“With a strict zero-Covid policy in place, lockdowns and mass testing are likely to be implemented in more Chinese cities, which could further disrupt the global supply chain,” Chen notes.
“The surge in Omicron cases, continued stress in the China property sector and persistent downside risks to growth promoted the Chinese policymakers to implement additional macro easing measures” going forward.
The yuan’s longer-term destiny, though, is becoming clearer by the year. And don’t Japanese officials know it?