The People’s Bank of China is making its own history at the Olympics: first out of the gate with a digital currency.
It’s a record PBOC Governor Yi Gang’s team isn’t taking lightly. Though Covid-19 greatly limited attendance, those on hand can use special ATMs at Olympics venues. Foreigners can swap their banknotes into e-CNY, and experience the morphing of science fiction into financial fact.
Yet this week also sees the PBOC making history in another respect: the yuan’s fast-increasing role in the global payments race. Payments using yuan increased to a record 3.2% of global market share, according to the Society for Worldwide Interbank Financial Telecommunications, or SWIFT.
Just as important as the increase is, the explanation behind it is arguably even more important. The jump reflects international funds raising their holdings of Chinese government bonds in a big way, particularly in the last three months of 2021.
The yuan’s increasing popularity, in other words, is pushing demand for Beijing’s IOUs to record highs. There are many explanations for the yuan changing hands more frequently. They include gas giant Gazprom Neft’s move to invoice in yuan rather than dollars while fueling Russian airplanes.
The biggest, it seems, is growing trust in China’s currency and assets denominated in it.
Milestones matter. And as Wang Chunying, deputy head of the State Administration of Foreign Exchange, noted the amount of China’s domestic bonds held by overseas investors jumped by US$167 billion in 2021, putting them in the big time globally.
For now, Chinese government debt is looking at inflows of as much as $126 billion in 2022, strategist Becky Liu estimates at Standard Chartered Bank. That tally could increase should Beijing make progress reining in excess debt in the property sector.
The default troubles at China Evergrande Group and other giant developers aren’t going away. Still, the inroads the yuan is making as a payment medium could in and of itself increase the currency’s global status.
That was, after all, the overriding goal of Yi’s predecessor at the PBOC, Zhou Xiaochuan. From 2002 to 2018, Governor Zhou was instrumental in building credibility for the yuan.
Zhou was a protege of reformer Zhu Rongji, who served as premier from 1998 to 2003. Mentor Zhu took his cues from the days of Deng Xiaoping, whose modernization push in the late 1970s and early 1980s set the stage for the rapid growth the nation enjoys today.
Zhu oversaw the closing of roughly 60,000 inefficient state companies. He guided Beijing into the World Trade Organization.
In the years that followed, disciple Zhou helped sustain Zhu’s reform drive. One of the biggest payoffs came in 2016, when Zhou’s PBOC guided the yuan into the International Monetary Fund’s special drawing-rights program. The yuan’s inclusion in the IMF’s club of reserve currencies, joining the dollar, euro, yen and the pound, was a milestone all its own.
Since then, President Xi Jinping’s government took steps to increase the yuan’s share of trade and its role in global finance. Officials added and widened channels for foreign investors to buy mainland stock and bond markets.
Mainland shares were added to the MSCI index, while government bonds were included in the FTSE-Russell benchmark. These wins for Beijing mean that many of the biggest funds around the globe will be upping their holdings of yuan-denominated assets.
Earlier this week, Yi surprised no one with a call to emerging economies to increase the use of local currencies to cut the region’s reliance on the dollar amid the risk of Federal Reserve tightening in Washington. That, Yi told Group of 20 nations peers, means strengthening the financial safety net against external shocks.
“Emerging markets should improve their resilience,” Yi says. “This is where regional cooperation has a key role to play.”
Regionally, bilateral currency swaps among Southwest Asia, China, Japan and South Korea are in the $380 billion range. In January, the PBOC extended its direct swap arrangement with Indonesia’s central bank. This suggests similar moves elsewhere in Asia.
Yi also appeared to warm major monetary authorities – including the Fed, presumably – to act prudently so as not to trigger another “taper tantrum” at a moment when Covid-19 fallout has world markets on edge.
“Central banks from advanced economies should continue to enhance market communications,” Yi says. He noted economists’ worries that emerging economies could face powerful capital outflows if top central banks act rashly.
Yet this fear, too, could play into Beijing’s hopes of increasing the yuan’s regional role. That and this year’s start of the giant Regional Comprehensive Economic Partnership trade deal, which puts China at the very center of Asian trade.
Strategist Alvin Tan at Royal Bank of Canada says Beijing is well-positioned to benefit from “trade between various Asian countries and China grows, and more of it is denominated in yuan.”
Come July, these developments could accord the yuan an even larger share of the IMF’s reserve-currency basket in July. The RCEP, meanwhile, will likely have Asian neighbors significantly boosting yuan asset holdings as an offshoot of increased trade links with their top trading partner.
By SWIFT’s numbers, the yuan is now the fourth-most used unit for cross-border payments, up from the 35th back in 2010. Yet the yuan’s role is still minimal relative to the dollar’s 40% share of global payments and the euro’s 37% weighting .
Surely, the yuan surpassing the yen has some bragging-rights value for Beijing. This 2010 bookmark is important for another reason: in that same year, China topped Japan in gross domestic product terms.
Arguably, the PBOC’s e-CNY moment at the Olympics these last two weeks pays into the narrative of an ascendant yuan. While the Fed, European Central Bank and Bank of Japan “study” a central bank digital currency, China’s is already essentially operational.
The cynical take on the PBOC’s achievement here is that only about 2 million, or $316,000, e-CNY transactions are being made per day, estimates Mu Changchun, director-general at the Digital Currency Research Institute. Yet that’s $316,000 of daily digital transacting that’s not taking place in New York, Frankfurt or Tokyo.
As the physical yuan gets its due globally, though, the pressure’s on both the PBOC and Xi’s team to get the financial basics right. In the short run, that means loosening monetary policy to smooth over default risks in the property sector.
Economist Carlos Casanova at Union Bancaire Privée notes that the PBOC’s stance has pivoted from what he calls “cross-cyclical adjustment” to “counter-cyclical support.”
Since late December, the PBOC implemented broad-based interest rate cuts to the 1-year and 5-year loan prime rates, the 1-year medium-term lending facility and 7-day reverse repurchase agreements. The bank trimmed reserve requirement ratios and unleashed $190 billion of additional liquidity.
Yet the PBOC needs to tread carefully, Casanova says. “Inflation will start its gradual ascend starting in April, amid rising energy prices,” he says. As such, the monetary stimulus can only go so far. “Easing will not be restricted to monetary policy,” Casanova says. “We expect additional fiscal stimulus measures to be announced ahead of the National People’s Congress in early March.”
The bigger-picture reforms, though, are far more important. China’s warped debt dynamics are a case in point. In market economies, corporate leverage and home prices tend to move in tandem, says Benjamin Della Rocca, an economist at the Council on Foreign Relations. When the economy is strong, corporate borrowing and home buying rise. They fall when growth weakens.
“But the opposite is true in China,” Della Rocca observes. “Since Xi Jinping took power in 2012, Chinese corporate leverage and home prices have correlated negatively. The reason? Despite ever-rising imbalances in real-estate and corporate-credit markets, Beijing knows that a downturn in either would jeopardize short-term growth. So as policymakers curb property speculation, they funnel risky loans to corporations to keep growth up. Later, as default risks rise, they do the reverse.”
To Della Rocca, this pattern suggests Beijing, post-Evergrande crisis, “will continue siphoning credit to property developers and state-owned enterprises that use loans unproductively. And, indeed, Beijing is now compensating for the Evergrande growth hit by allowing real-estate developers to borrow directly in the bond markets, while Chinese local governments are subsidizing home buying.”
This cycle must change if the yuan is to become a top-three currency and win the trust of global investors. For now, though, Xi and his PBOC can take solace that the yuan is moving ever close to center stage in financial circles, not just Olympic ones.
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