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China's Renminbi: The Rise of the 'Redback'?

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China's Renminbi: The Rise of the 'Redback'?

by Virendra Singh, Moody's Analytics, 05 January 2011
topics:
Risk Management
tags:
capital account euro global currency renminbi U.S. dollar
  • China is gradually moving to boost the international use of its currency.
  • Debt markets are expanding at home, while the government is allowing greater yuan trading outside China.
  • Eventually the yuan could be a fully convertible medium of global trade and finance.
  • Some speculate that the yuan could supplant the U.S. dollar as the dominant global reserve currency within a century.
 
With the U.S. dollar trending lower and the euro at risk from Europe’s fiscal problems, the Chinese yuan appears to be rising as a potential global currency. Either proactively or reluctantly, China appears to be gradually moving to allow greater international use of the yuan in trade and finance, and some observers have even nicknamed China’s currency the ‘redback,’ implying that it might become an international currency comparable to the U.S. greenback.
 
International importance
Though China’s economic growth has become a driving engine of the world economy, its currency has until now remained tightly controlled. Within limits, importers and exporters can convert Chinese currency to settle merchandise trade transactions, but it is essentially impossible for investors to trade financial assets in yuan. As a result, China's central bank has accumulated nearly US$2.6 trillion in foreign currency, the largest such holding in the world.
 
China’s monetary and financial policies are thus critical to the global economy. China is already one of the biggest lenders and investors in the world; its banks and companies are major investors in Asia, Africa and Latin America. China is a major source of soft loans in developing countries. Its investments and loans in Africa are powering a rebirth of the long-neglected continent. And any movement in the yuan or in interest rates sends ripples through financial markets.
 
The global financial crisis and subsequent recession threatened to destabilize global currency arrangements, previously dominated by the U.S. dollar and the euro. This has engendered a lively debate among Chinese policymakers over the future of the yuan.
 
On one side of this argument are quantitative economists, mostly educated in the West, who argue for a gradual move towards a floating, fully convertible currency. On the other side are political economists who view any loosening of state controls over the currency as a threat to China’s economy, citing the Plaza Accord, which paved the way for Japan’s economic bubble and subsequent bust in the late 1980s.
 
Baby steps
China is delicately navigating the currency road. In 2009, it took a first step towards making the yuan convertible, initiating currency swap agreements with major trading partners (excluding the U.S. and euro zone) at the height of the financial crisis. At a time when credit for trade was largely unavailable, these swap agreements were designed to replace the dollar as a currency of trade credit. 
More recently, China has taken the next step to liberalize its currency policy: creating a market for yuan trading outside the country, while retaining its monopoly over currency on the mainland. Since July, when banks and individuals were allowed to trade yuan outside the country, the volume of such trade has risen near US$400 million daily.
 
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