China has been taking significant steps in a bid to internationalise the yuan. The launch of new yuan-denominated copper futures this week is only the latest in a series of new measures intended to open the country’s capital markets and increase the currency’s usage internationally.
For over a decade, China has been attempting to promote the role of the renminbi (RMB) (as the yuan is also known) in international markets, and has done so with considerable success. In 2015, the RMB became the fourth most-used currency in the world for international payments, rising seven places in the space of three years, and in 2016 it was added to the IMF’s basket of reserve currencies. In recent years, its rate of internationalisation has slowed down, although the yuan’s move to the top remains a clear goal for Chinese policymakers. At the October Bund Summit in Shanghai, the People’s Bank of China Governor Yi Gang said they planned to continue their currency’s market-oriented internationalisation alongside the opening up of China’s capital markets.
So, what makes a currency ‘internationalised’? First and foremost, its use outside of its home economy must be widespread, meaning that it is frequently used in international transactions between foreign parties. There should also be no restrictions on how the currency may be traded or on who can hold it in reserve, including both private and public entities. The US dollar is the best example of an internationalised currency: it is used widely in international financial markets, denominating multitudes of products from commodities to Eurobonds; it accounts for just over 60% of global foreign exchange reserves; and it was used in 88% of FX transactions in 2019. The euro, the Japanese yen and the British pound are other examples of internationalised currencies; the yuan must challenge these to affirm its global role.
This year has seen huge growth in foreign demand for Chinese onshore bonds, aiding the RMB’s continued internationalisation. As central banks around the world cut rates in response to the economic downturn caused by the pandemic, many investors turned to China for its positive economic fundamentals and higher yields. 10-year government bonds currently offer a yield of 3.3%. In September, foreign holdings of China’s domestic debt reached a record high of 3 trillion yuan ($456bn), however, the addition of China’s government bonds into the FTSE World Government Bond Index next year could spur additional inflows totalling $140bn. This is not only a huge step in the liberalisation of China’s capital markets, but should also encourage a significant increase in foreign holdings of renminbi.
At the beginning of November, China also eased regulations to allow foreign investors greater access to its capital markets and to further promote the international use of the RMB. The rules for Qualified Foreign Institutional Investors (QFII) and the renminbi counterpart, RQFII, have been merged and loosened. Foreign institutions are now able to trade in onshore futures and derivatives markets and restrictions on the size of positions foreign investors can take have been removed. As was suggested at the Bund Summit a few weeks ago, policymakers are removing obstacles to the yuan’s free use by further opening China’s capital markets.
Thursday’s launch of renminbi-denominated copper futures on the Shanghai International Energy Exchange is the most recent step to expand the currency’s international use. Foreign investors are allowed direct access to the new contracts. In the past, similar renminbi-denominated futures have been launched for both crude oil and iron ore, however, the new copper contracts are set to be the most successful. China consumes over 50% of the world’s mined copper, therefore the new domestic futures should allow the country greater pricing power, especially as they have the potential to become the new global benchmark for copper. Such a success for these contracts would directly lead to an increase in the use of the yuan in international transactions outside of Chinese domestic markets.
All of China’s recent steps to liberalise its capital markets have set the yuan up for its best six months against the dollar and, unlike in the past, China has allowed the exchange rate to be relatively flexible. While this is obviously intended to aid the RMB’s internationalisation, this also represents a trade-off as the competitive price of Chinese goods is diminishing. However, this is being addressed by opening up markets gradually, instead of all at once.
As some have pointed out, the internationalisation of the RMB is likely to be a marathon, and not a sprint, however, the steps that China has taken to promote its use in recent months are significant. As more central banks and investors move to diversify their holdings, it is likely the yuan’s global status will continue to strengthen. However, there is still a way to go before the RMB can begin to pose a threat to the dollar as the international currency of choice.