You're Not the Yuan That I Want
In its ongoing quest for glory and global influence, China appears to have won a notable victory. The International Monetary Fund is set to anoint the renminbi -- the "people's currency," also known by the name of its biggest unit, the yuan -- as one of the world's reserve currencies along with the dollar, pound, euro and yen. For those who fear (or hope) that China will eventually transform the postwar economic order, this appears to be the first step toward dethroning the dollar.
The IMF's decision, however, is mere political theater. The yuan will now be included among the basket of currencies that make up its so-called Special Drawing Rights. As the IMF itself notes, “the SDR is neither a currency, nor a claim on the IMF.” Holders simply have the right to claim the equivalent value in one or more of the SDR’s component currencies. Central banks and investors won't suddenly be required or even explicitly encouraged to use the yuan.
Indeed, all that's changed is that it's now clear that the IMF isn't blocking the yuan from becoming a true global reserve currency: China is.
To the contrary, the IMF appears to be doing everything it can to help China. SDR currencies are meant to be "freely usable," which the IMF defines as “widely used to make payments for international transactions" and "widely traded in the principal exchange markets.” The yuan’s champions note that the currency has grown from being used in less than one percent of international payments in September 2013 to 2.5 percent in October -- among the top five globally.
This simple metric, however, enormously overstates the yuan’s influence. Globally, it’s still barely used more than the Canadian and Australian dollars. No one’s ever suggested including the loonie in the SDR.
True, China is the world’s second-largest economy and its biggest trading nation. Yet at the same time, more than 70 percent of payments made in yuan still go through Hong Kong, primarily due to its strategic location as a shipping and trading hub for the mainland. All but 2 percent of yuan-denominated letters of credit are issued to Hong Kong, Macau, Singapore, and Taiwan to facilitate trade with China. Even in Asia, the yuan isn’t accepted as collateral for derivatives trading and similar financial transactions. Instead it’s used almost exclusively for trade in physical goods where China is one of the counterparties.
Nor is the currency widely traded in financial markets. Hong Kong, the largest center of yuan deposits outside of China, holds less than 900 billion renminbi, or about $140 billion. That’s $40 billion less than Coca-Cola’s market cap (and barely a fifth the value of Apple’s). The entirety of yuan deposits held outside of China still amounts to less than the market capitalization of the Thai stock market.
This isn’t the result of prejudice against China, but deliberate policy. Take the oft-cited statistic that 2 percent of global reserves are already held in renminbi. Virtually all yuan reserves are held under swap agreements with the People’s Bank of China, rather than as physical currency. That means China’s central bank maintains control over the currency and its pricing and can refuse transactions if needed, as it did last week when it ordered banks to halt renminbi lending offshore. While other central banks have significant latitude to engage in onshore renminbi purchases, they face restrictions on using the currency outside China.
Earlier this year, the government allowed clearing banks outside China to engage in repurchase agreements where they provide an asset to the PBOC to borrow yuan. As BNP Paribas has noted, however, offshore renminbi transactions must still go through state-owned Chinese clearing banks, which surrenders “precious data and the control of a transaction.” All this hardly meets the definition of a “freely used” international currency.
Bulls say that including the yuan in the SDR will give a boost to reformers, who will open up the Chinese financial system over time. The problem is that there’s little evidence to support such optimism. Over the past two years, renminbi usage in financial markets outside China has been flat. According to Barclays, the amount of offshore yuan-denominated debt has shrunk since the middle of last year, while deposits in Hong Kong haven't changed much since January 2014.
The irony is that there is, in fact, enormous demand for more yuan among international investors and central banks. Goldman Sachs has estimated that $1 trillion in international reserves would flow into Chinese debt markets if the government truly opened them up.
Yet as economist Barry Eichengreen has noted, when it comes to reserve currencies, investors care most about “size, stability, and liquidity.” China’s firm grip on the yuan undercuts all three: It limits the pool of renminbi available and subjects the currency’s movements to the whim of Chinese policymakers.
Investors everywhere are prepared to tolerate some currency and asset price volatility. What they fear are haphazard policy responses, kneejerk regulation, and opaque institutions -- all of which are hallmarks of Chinese financial regulation. As long as central banks and investors have to worry about whether they can buy and sell renminbi as and when they need, the IMF’s stamp of approval isn’t going to make the currency any more attractive.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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