HONG KONG – China has set aside the project to internationalise its currency, and Asia might come to regret it. The region could use more hedges against dollar-denominated shocks in the Trump era.
The case for the yuan taking a place alongside the dollar, euro, pound and yen once looked solid. Foreign investors saw a big, fast-growing economy with high sovereign bond yields. For Beijing’s part, China’s leaders were frustrated by their exposure to monetary policy set in Washington.
Officials backed the development of offshore yuan markets in Hong Kong, London, Singapore and even Taiwan. They rolled out schemes making it easier to trade and invest in yuan, while foreign banks, excited by the prospect of selling whole new lines of related products and services, churned out reports on how to profit from doing so. The renminbi – the yuan’s formal name – joined the International Monetary Fund reserve currency basket last year. Optimists hoped that would galvanize a new wave of reform.
Instead, the tide receded. In December, only 11.5 percent of goods traded internationally were paid for in yuan, the lowest level in more than three years, according to Standard Chartered. Yuan deposits in Hong Kong, the largest offshore yuan centre by far, have nearly halved since peaking at slightly over 1 trillion yuan ($146 billion) in 2014.
The yuan-denominated “dim sum” bond market has gone to sleep. Worldwide, dim sum issuance shrank 21 percent to 22.5 billion yuan in 2016, Reuters data shows. In comparison, six major Asian economies – Japan, South Korea, China, the Philippines, Indonesia and Malaysia – issued a combined $250 billion in dollar bonds, up 27 percent from 2015.
The contrast with the U.S. dollar, a currency that can be found and traded nearly anywhere in the world, is stark. The yuan today is mostly trapped inside Chinese markets, traded between mainland firms and regulated heavily by the Chinese government.
Beijing seems indifferent to this retreat. There are no imminent plans to issue more sovereign yuan bonds in London, the leading foreign-exchange market. Officials are happy to let foreign investors into onshore assets, but at the same time the government makes it ever harder to get money back out.
Schemes letting outsiders buy onshore stocks and bonds have thus seen tepid take-up. Central bank data shows foreigners cut Chinese bond holdings in January, within four months of the currency joining the IMF basket.
NEW WORLD DISORDER
The problem began with America’s resurgent economy. That fed a greenback rally from late 2014, helping knock more than 10 percent off the yuan. Expectations of further depreciation have encouraged firms to swap yuan for dollars. That squeezes money-market liquidity in China, making it harder to gin up the economy by cutting interest rates. Steadily shrinking forex reserves – now below $3 trillion for the first time since 2011 – look to some like a vote of no confidence in China’s future. Every month brings a fresh crackdown on outflows.
It was always going to be a challenge to make the yuan viable offshore. The dollar’s ubiquity is sustained by a long-running trade deficit that exports dollar payments in exchange for goods. China now runs a $500 billion-plus annual surplus. Outbound investments in yuan could compensate, as could currency-swap lines with central banks, but lifting the yuan’s share of overseas investment and reserves to significant levels would take a huge effort.
Not that it wasn’t worth a try. The yuan’s retreat seems to have intensified the world’s unhealthy dollar dependence. Net global forex reserves have shrunk since 2014, IMF data shows, but the dollar’s share has risen.
Asian economies, which are particularly well-positioned to increase their use of the yuan, have instead dollarised even more. Bank for International Settlements data shows dollar claims on developing Asia-Pacific counterparties stood at $1.1 trillion in September, slightly below June’s record high.
This may be the worst time in history for indebted developing economies, including China, to be overexposed to the greenback. President Donald Trump is a policy wild card. His spending could overheat inflation; his diplomacy could start a trade war or worse. A dollar liquidity squeeze is a distinct possibility, especially if the United States increases its energy independence or otherwise cuts its trade deficit.
Having halted yuan globalisation to protect domestic growth, Beijing will find it extremely hard to restart quickly, if ever. Asia is more stuck with the dollar than ever.
– China sought to increase the international usage of its currency in global trade and investment by liberalising its capital account and successfully lobbying for the currency’s inclusion in the International Monetary Fund’s reserve currency basket, which it joined in October 2016.
– Chinese regulators have moved to stem capital flight by making it more difficult for individuals, corporations and banks to move money out of the country.
– Chinese borrowers have joined other Asian economies in ramping up dollar borrowings in recent years, taking advantage of relatively cheap rates. As the United States hikes policy rates and pushes to reduce its trade deficit under President Donald Trump, some economists fear an offshore dollar liquidity squeeze could result.
– The dollar index has gained around 25 percent since 2014. Asian currencies have fallen sharply.
– China’s foreign-exchange reserves fell below $3 trillion in January from a peak of nearly $4 trillion in 2014. That marks their lowest level in nearly six years, as capital has continued to flow out of yuan assets.