Yuan’s expanding influence highlights balancing-act between stability and reform
Print Edition
chinese VIEWS
The yuan has emerged as the fifth most-used currency in international business transactions, with 2.07 percent of the global payments made in the yuan in April. The trend is stronger in the Asia-Pacific region, where the yuan has emerged as the first-choice payment currency in China’s mainland and Hong Kong, while only three years ago it ranked a distant fifth in terms of popularity as a currency for payment.
The Hong Kong and Shanghai Banking Corporation has even predicted that the yuan will replace the yen as the most-used currency in Asia by the second quarter of this year.
The yuan is no longer under-valued and it is a matter of time before it joins the IMF’s Special Drawing Rights (SDRs) club. Once the yuan is included in SDRs, central bankers all over the world will naturally increase their holdings of the yuan in their foreign exchange reserves, a move that will likely help to stabilize its value.
What’s more, the yuan’s cemented role as a payment and reserve currency will inevitably lead to its greater influence in setting global commodity prices. At present, it has minimal influence compared to that commanded by the US dollar and the euro.
The yuan’s internationalization is also hugely important in light of the need for asset security, which is a key concern of Chinese businesses with global aspirations. And this concern is increasingly desperate in the wake of the 2008 global financial crisis, prompting Chinese authorities to moot the strategy of elevating the yuan’s global status.
A series of efforts, such as allowing for the yuan’s cross-border use in the Shanghai Free Trade Zone, currency swap deals featuring the yuan, the establishment of the Silk Road Fund and the Asian Infrastructure Investment Bank, have underscored China’s commitment to promote the yuan as a global currency in an organized way.
Risk control
Nonetheless, I’d like to shed light on some fundamental changes in the yuan’s internationalization which merit due attention.
Since risks abound of speculators making arbitrage gains from exchange rate differences, thanks to a unilaterally rising yuan, the Chinese government proceeded with great care in their previous bid to globalize the currency.
But today, not only Chinese firms themselves are eagerly engaged in yuan settlement in cross-border trade, their overseas partners no longer shy away from involvement in yuan-related business.
However, I do feel that although expectations for a stronger yuan are generally high, both at home and abroad, the ways to achieve that goal are perhaps seen in broadly different terms.
While the idea of building a financial infrastructure conducive to the yuan’s globalization holds some sway, Chinese authorities continue to insist on “risk controllability” as the primary prerequisite for financial deregulation and institutional reforms.
Only when cross-border use of the yuan and cash flows are stable and secure can the currency avoid the same tragic fate that befell the yen and the euro, both of which suffered severe setbacks in their internationalization processes.
However, the priority given to risk control is precisely where market observers think China should improve, and it is giving ammunition to the US, which is opposed to a stronger yuan because of its debilitating impact on the dollar.
The contrast between efficiency, favored by the market, and stability, emphasized by the government, has never been starker amid an anemic global economy and excessive liquidity in the financial market.
True, China’s financial regulators can push through parallel reforms in liberalizing the capital market and freeing up the capital account, so as to strengthen their risk control ability, but as long as these two reforms remain separate, risk assessment can only be inadequate and inaccurate. In short, the yuan’s foothold in overseas markets will be flimsy if the two major reforms proceed independently of each other.
The fragility of China’s financial system constrains the innovation ability and blunts the competitive edge of Chinese companies. Therefore, the ongoing financial reform spearheaded by established big players, like the Big Four state-owned banks, will be limited in its effects.
Driving Chinese financial reform by creating a more open capital market and introducing formidable foreign competitors is thus a painful yet much-anticipated option. The snag is, in the case of delayed financial reforms as well as sluggish investments in the real economy, the market will certainly be distorted in favor of those speculators bent on making arbitrage gains.
Policy implications
Here are some policy suggestions.
First, while there is little disagreement on boosting the yuan’s international clout, consensus on how to realize this ambition is increasingly elusive. The key is to use China’s dollar reserves efficiently and lay an overseas groundwork for the yuan’s involvement in global trade and investment.
Secondly, evaluation of the yuan’s global heft cannot depend solely on the amount of yuan payments done abroad; rather, it should rely more on building a healthy financial infrastructure at home.
Thirdly, we ought to address timely the twin conundrums of industrial upgrading and financial distortions, so as to speed up the capital account liberalization before the next market boom arrives.
The author is executive dean of the School of Economics at Fudan University. The views are his own. Shanghai Daily staff writer Ni Tao translated his article from Chinese.
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