By Jukka Pihlman
Adopted at pace by central banks around the world, China’s yuan is now seen by many as a de facto reserve currency – and well underway to becoming an official one.
Central banks have caught the yuan fever, showing strong interest in investing part of their foreign-currency reserves in the Chinese currency, with more than 50 central banks now actively doing so either onshore or offshore.
Uptake is strongest in Asia, Africa and South America – regions with fast-growing trade and investment links with China – but even in Europe central banks are busy allocating reserves to yuan.
Earlier this year, Banque de France announced it is active in the yuan market, and in July the Swiss National Bank received a 15bn yuan investment quota from the People’s Bank of China (PBoC), the Chinese central bank. The actions of these two large and sophisticated players are likely to reverberate in the European central-bank community, sparking others to follow. The allocation shift by central banks is all the more remarkable, given that the yuan does not yet qualify for official reserve-currency status. It is a powerful indicator of the great expectations in the yuan as the currency continues on its irreversible path towards internationalisation.
Whilst the yuan is unlikely to challenge the US dollar’s dominance as a global reserve currency any time soon, the international monetary system is rapidly becoming ‘multi-polar’, with the yuan gaining in prominence as a reserve and transaction currency.
Currently the world’s seventh most used currency for payments, the yuan is predicted to be fourth by 2020, after the dollar, the euro and the pound. As such, for many central banks, investment in the yuan makes increasing sense, as holding yuan reserves effectively acts as a buffer for covering a country’s import bill from China.
PBoC has helped pave the way for yuan adoption by foreign central banks, giving them special direct access to invest in the yuan interbank bond market. The Chinese authorities have also given central banks preferential treatment in its Qualified Foreign Institutional Investor (QFII) quota scheme, and in the offshore market, the Chinese Ministry of Finance has guaranteed foreign central banks an allocation in auctions of its bonds, a move unprecedented by any sovereign funds.
According to the IMF’s rules, the yuan can’t be reported as an official reserve currency by central banks, because some controls on the currency remain in place, which means it’s not technically ‘freely usable’. This means that – in the eyes of the IMF – any sum invested in RMB disappears from the reserves.
Some central banks have started to report their offshore and onshore yuan investments as official reserves anyway, indicating that they believe the criteria of ‘freely usable’ has been met in practice.
This is possible, despite IMF reporting rules, because central banks do not need to disclose the currency composition of their reserves when reporting to the IMF and the IMF does not rigorously scrutinise what is being reported, unless a country is under an IMF programme.
The move by central banks demonstrates the powerful role that both the public and private sectors are currently playing in shaping the yuan’s future. The IMF – with its central role in the international monetary system – is a particularly key player. If the yuan were to be included in the IMF’s Special Drawing Rights (SDR) reserve asset (effectively a basket of reserve currencies), which is up for review next year, it would be a significant step up for yuan internationalisation.
Effectively, inclusion in the SDR would serve as an official acknowledgement of the yuan’s reserve-currency status, and central banks of all IMF member countries would automatically gain yuan exposure through their SDR holdings. It would encourage new central banks to enter the yuan market, and those already there to increase their allocations.
However, even without taking this step, the IMF could play a key role by setting out how yuan investments can be reported ‘officially’ to ensure that smaller central banks and those on IMF programmes – for whom current reporting rules could be an issue – are not put off from investing in yuan. In its approach to the yuan, the IMF should let itself be guided by facts and technical analysis of yuan usage, not by politics. There is little doubt that the stability of the international monetary system would stand to be vastly improved, if central banks were allowed to manage their foreign reserves in a manner that reduces their vulnerability to external shocks. Given the dominance of China as a global trader, and the rapid internationalisation of its currency, for most central banks this will invariably mean investing a larger proportion of their foreign currency reserves in yuan.
Jukka Pihlman is managing director global head of central banks and sovereign wealth funds at Standard Chartered. The views expressed are his own.
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