China has 'rare opportunity' to accelerate yuan internationalisation, but 'scope limited'

After years of promoting international use of the yuan, China is now in a position to grow its influence in global transactions, analysts said, amid a rising number of countries willing to use the Chinese currency for payments.

Since Russia's invasion of Ukraine last year, the United States and its allies have blocked Russia's central bank access to its foreign reserves, as well as banning several Russian banks from the Swift international payments network.

Greater international use of the yuan will provide channels for busting US-led sanctions, analysts added.

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The yuan has now become a regional reserve currency for Russia as it seeks to cut reliance on the US dollar.

Brazil and Bangladesh are among the countries that have since accepted trade settlements and investments in yuan, while Thailand's central bank has said it will relax rules on the use of the yuan for trade this year.

"The financial system was used as a response to the invasion of Ukraine, to an extent that it has never been seen before, all the indications are that it has had a very substantial impact on Russia," said Carl Tannenbaum, the chief economist at Northern Trust, and a former senior official at the Federal Reserve Bank of Chicago.

"As economic, political and geopolitical issues become intertwined, the issue of whether the payment system will be used as part of that conflict is something that is justifiable and has been studied by all of those who might be involved."

Lian Ping, chief economist of Zhixin Investment, believes China now has a "rare opportunity" to accelerate international use of the yuan.

China's increasing share in global trade, together with a stable currency, provide strong incentives for the yuan to be used in settling payments, Lian said in an op-ed in the Tsinghua Financial Review last month, which was co-written with Zhixin analyst Deng Zhichao.

"[The trend for] de-dollarisation has opened up new room for the internationalisation of the yuan. China should take advantage of the trend, seize the opportunity, take the initiative, and promote the internationalisation of the yuan in an orderly manner," the op-ed said.

China has been keen to promote the yuan, as well as reducing its reliance on the US dollar.

It has developed a global payment system Cross-Border Interbank Payment System (CIPS) as an alternative to Swift.

China has also been a front runner in testing the use of digital yuan, known as the e-CNY, which can help promote the yuan in cross border transactions.

Since 2018, China has also been exploring different ways to transform the functioning of global trade relationships to help the yuan displace the US dollar in global payments, according to research by Enodo Economics, a macroeconomic and political forecasting company in London.

Beijing's aim is to institutionalise overseas demand for the yuan through commerce with a focus on developing economies, Asian countries and members of Beijing's Belt and Road Initiative, according to Enodo Economics.

"Asian supply chains are typically denominated in dollars because, in the past, the main consumer of the end product was usually the US. Beijing wants to make the yuan the currency of choice by establishing China as the anchor of an Asian trade bloc," said Enodo Economics.

Similar efforts are seen in shifting the epicentre of global commodity futures trading from the US to China to make the yuan the dominant currency for settling and pricing commodity transactions.

Efforts to encourage Chinese capital to go abroad and fund resource extraction and processing facilities to produce goods that will be sold to China, in yuan, is also under way, Enodo Economics added.

The yuan's share in global trade financing has risen from less than 2 per cent in 2017 to 4.5 per cent this year, helped by Russia's enforced switch to the yuan and lending via the Belt and Road Initiative, with more than 30 swap lines set up by the People's Bank of China (PBOC), according to London-based research firm TS Lombard.

As of the last quarter of 2022, the yuan made up around 2.7 per cent of central banks' foreign exchange reserves, up from less than 1 per cent in 2016, according to data from the International Monetary Fund.

The yuan, though, has made small gains in its share of global trade and payment despite China's efforts.

Analysts believe while Beijing is encouraged by increased interest from its trading partners in using the yuan, its foreign exchange regime is not yet ready to accommodate large pools of its currency outside its home market because it may lose control over its value.

China practices strict controls of cross border fund flows, with the PBOC carefully managing the yuan's exchange rate against major currencies.

"Yuan use for trade between Russia and third economies is only going to have limited scope as most economies don't want to be in the sanctions-busting business and for those that might, accumulating yuan is again only useful if you have something you really want to spend it on in China," said Adam Slater, the lead economist at Oxford Economics.

"Beijing is doubtless happy to see more international use of the yuan, but only on a limited basis. The main aim is more to bind Russia and perhaps others more tightly to it in trading and financial dependence."

Enodo Economics said for yuan internationalisation to advance, China will have to change the way it manages the economy.

"Specifically, as the volume of yuan accumulating offshore increases, the ability of the PBOC to control the value of the yuan will gradually diminish," Enodo Economics said.

"Instead, the central bank will have to rely on interest rates to manage both the currency and the broader economy, itself a significant shift. The PBOC has been actively preparing for such a future."

This article originally appeared on the South China Morning Post (SCMP).

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