China’s yuan internationalisation faces coronavirus, geopolitical threats despite record cross-border use

Geopolitical tensions and the coronavirus are expected to challenge Beijing’s bid to further increase the global use of the yuan even after its share of China’s cross-border payments hit a record high last year. China’s cross-border settlements denominated in yuan accounted for 47.4 per cent of all of domestic and foreign currency transactions last year, 9.28 percentage points higher than 2019, according to a report on the yuan’s internationalisation by the China Banking Association. Cross-border use of the yuan also surged by 44.3 per cent year on year to 28.38 trillion yuan (US$4.37 trillion), of which receipts reached 14.1 trillion yuan and payments rose to 14.28 trillion yuan. Favourable conditions for the increase included the launch of regional pilot projects in the Greater Bay Area, Shanghai Free Trade Zone and Hainan Free Trade Port, the report said, while China’s relaxation of access to its financial markets also boosted foreign investments into domestic bonds. US-China tensions risk spreading beyond the realms of trade, investment, and technology in the future, and in turn could exert pressure on the international development of the yuan China Banking Association “US-China tensions risk spreading beyond the realms of trade, investment, and technology in the future, and in turn could exert pressure on the international development of the yuan,” said the report from the 769-member China Banking Association, which was established in 2000 to promote the development of the banking industry. “Since 2020, the global economy has been affected by the coronavirus epidemic and has fallen into a severe recession, global financial markets were turbulent and trade protectionism has been on the rise. Under the influence of the epidemic, the process of yuan internationalisation is facing various internal and external challenges.” Bernard Aw, Asia-Pacific economist at credit insurance firm Coface, said depreciation pressure on the yuan could result from the US Federal Reserves looking to normalise monetary policy by reducing quantitative easing and raising interest rates. The yuan’s exchange rate against the US dollar has been relatively stable so far this year, but China may go the other direction, potentially cutting reserve requirement ratios further to ensure ample liquidity in the financial system, especially for the small and medium-sized enterprises. “The midyear economic work conference held by the Political Bureau of the Communist Party of China Central Committee highlighted growing pressure on China’s economic recovery in the second half of the year,” Aw said. “The current Chinese recovery remains unstable and uneven, according to the meeting, with current economic challenges compounded by the evolving global Covid-19 trajectory and an increasingly complex and grave external environment.” Yuan internationalisation needs ‘persistent, strong foreign demand’ Even though China’s total gross domestic product accounted for nearly 17 per cent of the world’s total in 2020, the yuan’s share of total international settlements and global exchange reserves remains modest at around 2 per cent, well behind the US dollar, the euro and the Japanese yen. History shows that the internationalisation of the British pound and the US dollar were market-driven, natural processes that accompanied the growth of their own political and economic power, according to a report by Bank of China (Hong Kong) chief economist E Zhihuan and research analyst Ding Meng. In the 18th century, Britain relied on the Industrial Revolution to establish a strong industrial system, importing raw materials from foreign countries while exporting industrial products to the rest of the world. By the 19th century, Britain was the most economically powerful country in the world based on the trust in its economy and ability to exchange the pound for gold. All countries were willing to use the British pound for international settlements, and the rise of the currency gradually replaced the Spanish silver dollar as the main international currency. Similarly, the internationalisation of the US dollar benefited from the United States’ gradual replacement of Britain as the world‘s largest economy at the end of the 19th century. The Bretton Woods International Conference held in 1944 marked the official formation of an international monetary system dominated by the US dollar after World War II. When the Bretton Woods system collapsed in the early 1970s, the US dollar became the main international credit currency. But the internationalisation of the yuan has followed its own unique development path, the Bank of China report said. The global use of the yuan is the result of both policy-driven and market-driven activities, with interaction occurring between the offshore and onshore yuan markets. The global use of the yuan is dependent on the People’s Bank of China’s yuan exchange rate policy mechanism, the report added. Why is the US dollar-yuan exchange rate important? China’s internationalisation model has deep-seated problems, preventing the smooth circulation of the yuan, said Zhang Ming, director of the China Chief Economist Forum and former chief economist of Ping An Securities. The network and services provided by Chinese commercial banks in the belt and road region are still inferior to those of US and European banks. Compared to US dollar or local currencies, customers have limited options in investment products denominated in yuan, invariably affecting the willingness to increase their yuan holdings, analysts said. The offshore financial market mainly provides investment and financing channels for yuan funds flowing out of China, but there is no effective way for offshore yuan assets to return because the domestic capital account is still not fully open. Foreign investors’ participation in the domestic financial market and foreign-owned domestic financial institutions are still subject to quota and restrictions for domestic investments, Zhang added.