China to world: Yuan is for trade, not investment

If earlier doubts about China’s commitment to make the yuan a global currency were misplaced, the current excitement is more than a little bit overdone.

Beijing’s strategy for the next few years can be summed up quite simply: Dear foreigners, please use our currency, but not as a way to profit from our country’s growth.

It is understandable why excitement is mounting. With more and more Chinese firms paying for imports in their own currency, the small pool of yuan abroad is increasing exponentially. And the menu of yuan assets on offer to foreigners, from dim sum bonds to swaptions, is getting bigger by the day.

But the reality of China’s incrementalist approach to reform will soon set in.

The offshore  yuan market is bound to disappoint global investors over the next couple of years because two big things they crave will remain on hold: China’s capital account will stay largely closed and yuan appreciation will proceed only at the plodding pace dictated by Beijing.

“It’s not very international at all. It’s just that it has made progress,” said Dariusz Kowalczyk, a senior economist with Credit Agricole CIB in Hong Kong.

What this means in practice is that the trade track for yuan internationalisation will far outshine the investment track.

When China launched a trial programme for settling trade in yuan last year, it restricted access to just a handful of foreign countries and Chinese cities.

Unsurprisingly, the numbers underwhelmed at first, and few market players thought that pledges to internationalise the yuan would amount to much in the short term.

But in June, Beijing allowed all nations and most Chinese provinces to settle trade in yuan.

Then in July, it gave Hong Kong a green-light to launch yuan-denominated products, a precondition for foreign firms to accept payment in the currency.

With those two strokes of the pen, the gates opened.   

Yuan-denominated trade flows have grown seven-fold to total 340 billion yuan over the last six months, official statistics show. From nothing a year ago, about 5% of Chinese trade is now paid for in yuan.

“Chinese policymakers want an even bigger share and they don’t mind the pace being rapid,” Kowalczyk said. “They can achieve a lot without opening the capital account massively wide.”