MacroScope

China at a crossroads on yuan internationalization project

By Saikat Chatterjee
September 3, 2013

As China marks the third anniversary of the first ever bond sale by a foreign company denominated in renminbi, questions are rife on what lies next for the offshore yuan market.

Since hamburger chain McDonalds sold $29 million of bonds on a summer evening just over three years ago, China’s yuan internationalization project has notched up impressive milestones.More than 12 percent of China’s trade is now denominated in yuan from less than 1 percent three years ago, Hong Kong – the vanguard of the offshore yuan movement – has more than one trillion yuan of assets in bank deposits and bonds and central banks from Nigeria to Australia have added a slice of yuan to their foreign exchange reserves.

China’s aim to internationalize the yuan has two major objectives: One, to ensure that its companies do not have to shoulder the foreign exchange risk of swapping yuan into dollars in global trade. The second is that as China gradually makes the transition from a current account surplus nation to a deficit country, it would, like the United States, want its debt to be denominated in its own currency.

But after some big early strides, Beijing faces an uphill climb. The yuan has failed to make a meaningful dent in global international trade outside Asia and China’s stock and bond markets remain underdeveloped, slowing the pace of the yuan’s internationalization.

In his book, “The renminbi rises:  myths, hypes and realities of RMB internationalization and reforms in the post-crisis world,” Chi Lo, a strategist with BNP Paribas, draws historical parallels between Japan’s experiments with internationalizing its currency and offers some clues on what lies ahead for China.

Like Japan, Beijing too has a large current account surplus which prohibits it from exporting its currency overseas. Also, a large chunk of imports of both these nations are U.S. dollar-denominated commodities, posing another obstacle for yuan internationalization, Lo argues.

On the financial side, foreign participation in China’s onshore markets is tiny and only allowed through small quotas. For example, combining debt and equities, total foreign investments is about 2 percent of the total market. With the capital account largely closed, it is understandable why large multinational companies are still hesitant to switch their trade invoicing into yuan with their Chinese partners.

But it is precisely these obstacles that makes China’s goal to make its currency a global player a more exciting story than its Japanese counterpart.

By opening up its capital account, Beijing can fast forward the pace of yuan internationalization. Various reforms taken this year are proof of that. By expanding into more offshore yuan centers in Taipei and Singapore and clearing a thicket of regulations around cross border transfer of yuan, Beijing has signaled it is playing the long game to rival if not eclipse the dollar in global trade.

Quite unlike the fast food nature of the U.S. hamburger chain that opened this market.

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