China still has lessons to learn in making the yuan an international alternative to the US dollar
- Beijing has spent years trying to internationalise the yuan with little to show for it because of its top-down approach and strict capital controls
- China can no longer take for granted that investors will always be waiting for market access and should be bolder in expanding the yuan’s use
It has been more than a decade since people started talking about tuning the yuan into an international currency as a possible alternative to the US dollar.
But despite the fanfare about the yuan’s potential, the Chinese currency’s international use remains low relative to the size of the country’s economy, trade power and geopolitical influence. Excluding exchange between Hong Kong and the mainland, the yuan’s use in international trade and investment remains very limited.
The greenback’s unrivalled position as the world’s reserve currency gives the US an “exorbitant privilege”, allowing it to borrow cheaply and exert financial muscle by, among other things, enforcing sanctions through the global financial system. As a result, China needs to boost the global use of the yuan to help cut its exposure to the US dollar.
Yuan’s rise will make only a small dent in might of US dollar
Efforts to internationalise the yuan received a shot in the arm in the aftermath of the 2008 global financial crisis. In 2009, China’s then central bank governor Zhou Xiaochuan tabled ideas on how to create a new global currency to replace the dollar, the dominance of which China blamed for the world’s recent economic woes.
Yet 14 years later, Beijing’s journey to make the yuan an international currency has been anything but smooth sailing.
One reason is excessive reliance on a “top-down” approach to internationalisation. In 2016, for instance, China was able to get the yuan included in the International Monetary Fund’s Special Drawing Rights (SDRs), foreign exchange reserve assets based on a basket of currencies, giving the Chinese currency greater status alongside the dollar, euro, yen and pound. But SDRs cannot be held by private parties, doing little for international adoption of the yuan among businesses.
China has also inked dozens of bilateral currency swap deals with other central banks, but these were mostly about status, and they are of questionable practical value.
In theory, if a foreign central bank inks a currency swap deal with China, it recognises the yuan as a source of emergency liquidity support. But it would be a bad deal for China to give yuan to a foreign central bank in exchange for an obscure, depreciating currency.
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Meanwhile, Beijing has done little to loosen its draconian capital controls, preventing businesses or individuals from expanding their use of the yuan outside China’s borders.
The People’s Bank of China, confident in its “countercyclical management capabilities”, has shown a distrust of the market and been trying to outsmart market players. The central bank expended huge resources between 2005 and 2015 to prevent “hot money inflows”, before making a 180-degree turn to curb outflows. The policy flip-flop may have achieved Beijing’s tactical objective of stopping big swings in capital flows, but the long-term strategic cost has been to undermine the trust of private investors.
After four decades of “reform and opening up”, the domestic financial markets in the world’s second largest economy remain largely closed. The lack of investment channels has significantly dampened interest in the Chinese yuan.
For many years there has been a default assumption that there would always be a large group of global capitalists eager to get a foothold in China, allowing Beijing to “open” the market bit by bit. But the winds are changing, and China may have missed the best opportunity to open onshore financial markets.
The inconvertibility of the yuan has been a mixed bag for the Chinese government. It is increasingly happy – or even proud – about the yuan’s detachment from global markets because it shielded the country from negative external shocks, but it also undermine’s China’s long-term goal of having a global currency.
China is set to win more battles in pushing the yuan’s use in trade and investment as a result of its growing economic clout. It is not surprising that Russia and Brazil are showing interest in the yuan, and a recent natural gas deal between China and France billed in yuan could be the first of many such deals to come.
At the same time, China should also take bolder measures to make it easier for businesses and individuals to use its currency. That is the only path to a truly global currency.
