China's "Global" Currency Goes Local
Last week’s decision by MSCI not to include Chinese shares in its primary emerging-markets stock index has been viewed -- widely and rightly -- as a blow to China’s hopes of internationalizing its financial sector. There’s worse news, though: Even the progress China’s made thus far is in danger of going into reverse.
MSCI's choice is a sharp contrast to the one made by the International Monetary Fund last December, when it promised to begin including the Chinese yuan in its basket of “special drawing rights.” The move essentially conferred global reserve status on the currency, despite the fact that China arguably didn’t meet the conditions for inclusion: It was debatable whether the yuan could be considered “freely usable,” and in any case, it was hardly used. At its peak in August 2015, the yuan accounted for 2.79 percent of global payments, compared to 44.8 percent for the U.S. dollar.
The idea was that compromising now would encourage leaders in China to fulfill their pledges to liberalize the yuan fully by 2020. In fact, since the IMF’s decision, the yuan has if anything grown less international, not more. Since March 2015, yuan deposits in the three largest offshore centers -- Hong Kong, Taiwan and Singapore -- have fallen 16 percent, to a total of 1.24 trillion yuan or about $188 billion.
The currency is being used in even fewer international transactions than before: Its share of global payments stood at 1.82 percent in April 2016. The fact that only a quarter of those international payments included a partner other than China or Hong Kong means that only about 0.5 percent of all yuan transactions are truly international in scope. This places the currency somewhere between those of Scandinavian powerhouses Norway and Denmark.
Most telling is the fact that even Chinese companies don’t seem to want to use yuan when doing business abroad. Chinese bank receipts in yuan from international transactions peaked in August 2015 and have since declined nearly 60 percent. Foreigners seem no more eager to hold and use the currency: Investment inflows -- which indicate willingness to hold Chinese assets -- have fallen 38 percent this year compared to the same period in 2015, while foreign direct investment is down 15 percent. Investment by foreigners in Chinese securities has plunged 61 percent.
What’s going on? For foreigners, concerns about the Chinese economy and the unpredictable nature of policymaking in Beijing have outweighed China’s attempts to lure outside capital. Institutional investors sending large amounts of money into and out of emerging markets understand the risks and volatility that come with the territory. But the seemingly ad hoc way in which Chinese regulators have interfered with the stock market and the currency since last summer have spooked even veteran investors.
Meanwhile, Chinese companies remain concerned about a possible devaluation of the yuan -- fears that were exacerbated after the government clumsily rolled out a new and uncomfortably opaque method of fixing the currency’s value last August. A cheaper yuan would make the dollar loans many firms have taken out much more expensive. So companies have been repaying those dollar debts and replacing them with yuan-denominated bonds at home. The net effect has been to draw yuan back to the mainland from offshore centers such as Hong Kong.
Above all, though, China has itself to blame for the de-internationalization of its currency. Ever since its surprise devaluation last August, the central bank has been worried about the tendency of the offshore yuan -- which is freely traded -- to drift away from parity with its onshore cousin. To prevent traders from pushing the two values too far apart, the PBOC has had to intervene regularly, buying yuan offshore to prop up its value and repatriating it back to the mainland.
For Chinese policymakers, the alternative is unthinkable. They’d have to allow the yuan to weaken significantly and probably abandon its unofficial peg to the U.S. dollar. This would further dampen foreign investment and unleash a flood of capital seeking to leave China, threatening liquidity in domestic banks and raising the risks of a financial crisis.
It’s hard to see China changing course. Even now, the central bank is selling 3 billion yuan worth of bonds in London, which will require more than 10 percent of the yuan available there and thus soak up even more offshore liquidity. Even joining the SDR basket at the end of this year will vacuum up almost 17 percent of all the yuan outside China.
Yet reversing course on internationalization has consequences, too. Unless the government eases its control over the yuan and lifts restrictions on capital mobility -- which MSCI cited in deciding to exclude Chinese stocks from its index -- companies and investors will remain reluctant to use and hold the currency. Meanwhile, capital within the country will continue to be allocated inefficiently, sheltering companies from true international competition. China has set a date for opening its financial sector for good reason. This isn’t the time to change targets.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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