By Giles Chance
Making the yuan into a fully convertible, internationalized currency has been talked about in China and around the world for more than two decades.
China is forecast to overtake the U.S. to become the world’s largest economy within 20 years. Already, China has a dominant influence on the global economy, and the yuan has become one of the world’s strongest currencies, appreciating more than 30 percent against the U.S. dollar since July 2005.
It seems appropriate that the yuan should play a major world role, alongside the dollar and the euro. The benefits for China are obvious: cheaper borrowing on world markets, the profits gained from the worldwide issuance of a widely used valuable paper currency and a reduced foreign exchange risk both for Chinese companies and for the management of China’s dollar reserves.
But for a long time these benefits were outweighed by the apparent disadvantages of a fully convertible yuan: the loss of capital control and of the Chinese government’s ability to intervene to assist uncompetitive Chinese exporters. It is only since the 2008 U.S. financial crash that the Chinese government has come to believe that the risks posed by internationalizing the yuan are smaller than the risks of continuing to rely on the U.S. dollar as the dominant global currency used for trade, a unit of account and a store of value.
As a result of this change of view, China’s 12th Five-Year Plan (2011-15) includes as an objective the internationalization of the yuan. The world’s traders, currency speculators and central bankers are closely watching how quickly this highly important development might occur.
It is easy to forget that in 1993 the government made a similar commitment to a fully convertible currency, and even set a time limit of 2000 by which it was to happen. But the Asian crisis of 1997 intervened, and the yuan liberalization program was shelved.
Although China has grown greatly in importance as a force in world markets since the 1990s, it is still not certain that the more recent commitment to yuan convertibility will be stuck to, because unforeseen events can get in the way.
But the events of the last year or so seem to indicate that the government is determined to meet its stated objective of a fully internationalized currency. At the beginning of 2012, Zhou Xiaochuan, governor of the People’s Bank of China, the central bank, declared “we are now not too far from our goal of capital account convertibility.”
According to the Society for Worldwide Interbank Financial Telecommunication, one of the major global financial settlement and payment platforms, the yuan has jumped up the ranking of world currencies used to settle financial transactions, from 35th in October 2010, to join the South African rand and the Danish kroner at 16th two years later.
China is continuing to drive the process. In March 2012, all licensed Chinese importers and exporters were allowed to settle their trade accounts in the yuan, providing a saving of 5 percent, according to a recent survey by Deutsche Bank.
In April, the central bank established an independent international payment system to enable cross-border yuan clearance. Since 2004, permission was given to 32 banks in Hong Kong to accept yuan deposits, Hong Kong has led the way in developing the yuan’s offshore role, and now accounts for 75 percent of the yuan’s offshore clearing worldwide.
Recently other financial centers, led by London and Singapore, have started to compete with Hong Kong in the yuan settlement market. In January 2012, to signal the new interest of London in the yuan business, the Hong Kong Monetary Authority and Britain’s finance ministry jointly launched a yuan offshore forum in Hong Kong.
In April, HSBC issued the first yuan-denominated bond outside the Chinese mainland and Hong Kong, raising 2 billion yuan ($320 million) in London. The HSBC bond issue was followed in London by Banco do Brasil, ANZ, and on Nov. 30 by China Construction Bank, which became the first Chinese issuer of a “dim sum” bond outside Hong Kong.
The fast growth of yuan deposits in Hong Kong — stimulated by the loss of confidence in the U.S. dollar in 2008 — slowed last year, probably indicating that the yuan deposit market is maturing into an investment market.
In August, there were 168 financial institutions worldwide offering real time gross settlement in the yuan, of which 128 were based in Hong Kong. But important technical hurdles to providing a seamless yuan cross-border settlement service remain, like translating the Chinese characters used to describe payment beneficiaries into English, and matching the internal code CNH used by banks for the Chinese currency with the international standard CNY.
In a recent speech in Hong Kong, Dai Xianglong, chairman of the Chinese National Social Security Fund and former governor of the central bank, said that no timetable had been set for yuan convertibility. Within China, the market needs to set both interest rates and the exchange rate, and the Chinese capital markets, particularly the bond market, need to develop considerably in depth and liquidity.
Outside the mainland, he said, Chinese financial institutions need to develop their branches in major economic and financial centers to increase their understanding and control of international financial flows and economic events.
Against this background of slow but solid development, 2013 looks like being another year of steady progress in making the yuan into an international currency. In 2012, Nigeria joined Chile, Brazil, Venezuela, Austria and a long list of Asian countries that hold the yuan as foreign exchange reserves, both as an investment and against imports of Chinese products.
In 2013, other countries will start to hold the yuan as a reserve asset. The case for doing so is growing stronger as China becomes a major trading partner for countries which sell natural resources, and whose emerging middle classes depend on reasonably priced Chinese products.
There is a long way to go before the yuan can match up to the requirements of a major international currency, which should command confidence and trade freely everywhere, be held in unlimited size by financial institutions wherever based, be used for invoicing without limitation and be widely held as a “reserve” currency by central banks as a backup to their own domestic monetary and economic systems.
It will be at least a decade before the yuan joins the euro and the U.S. dollar as one of the principal global trading and reserve currencies. But the direction is clear. Barring a major unforeseen event, we will see more evidence in 2013 that the yuan is on the way up.
The author is a visiting professor at Guanghua School of Management, Peking University. The views do not necessarily reflect those of China Daily.