Analysis: China to world: yuan is for trade, not investment

By Simon Rabinovitch

BEIJING, Dec 9 (BestGrowthStock) – 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.

“I don’t think they (Chinese officials) are in a rush. They would rather do things well than hurriedly,” he said.

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

As for the buffet of investable yuan assets — the CNH market — in Hong Kong, it will be big in significance, but not in size.

“This is a small, really small, tiny experiment in a lot of long-term strategic financial deregulations, in terms of interest rates, exchange rate and capital controls,” said Isaac Meng, economist with BNP Paribas in Beijing.

A London-based hedge fund strategist visiting Beijing last week put it succinctly: “I get that this is all important, but I can’t help but say ‘so what?’ There’s nothing in it for us.”


Yet Beijing’s determination to make the yuan a globally accepted means of payment should not be underestimated. That is the lesson of the past year.

When China launched a trial program 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 internationalize the yuan would amount to much in the short term.

But in June, Beijing allowed all countries 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 ($51 billion) over the last six months, official statistics show. From nothing a year ago, about 5 percent 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.”

If there was any doubt about the direction of reform, China this week expanded the number of domestic exporters who can bill in yuan to 67,359 from 365.

And Beijing still has much room for experimentation. At 217 billion yuan, yuan deposits in Hong Kong have tripled since the end of last year, but are still less than 0.5 percent of the deposit base in China — not enough to pose any macro-economic risks for the mainland.


Nevertheless, the government is alert to even the faintest whiff of danger. Hence its decision, reported by Hong Kong media last month, to shelve a plan that would have allowed offshore yuan to be channeled into the mainland’s stock markets.

A currency dealer at a foreign bank in Beijing also said there were signs that regulators were surprised at how many Chinese firms had taken advantage of the yuan’s slightly higher spot rate in Hong Kong by buying it on the mainland and selling it in the territory.

“There is no limitation on the offshore market. What they can do is use administrative measures to narrow the channels out,” she said.

So even as Beijing widens the scope for the yuan’s cross-border use, be on the look-out for moves to ensure that Chinese firms are truly buying and selling goods with their cash and not just seeking out arbitrage trading opportunities.


The 64 million yuan question is when China will abandon all of these controls and make its currency fully convertible under the capital account — the launching point for it to become a rival to the dollar.

Many in the market are working on the assumption that the government’s stated ambition of turning Shanghai into a global financial center by 2020 acts as a rough deadline.

Yi Gang, a central bank vice governor, noted in an interview earlier this year that, according to International Monetary Fund data, countries typically take 7-10 years to progress from current account convertibility to capital account convertibility.

China opened its current account in 1996, so it is well behind the average, Yi told Caixin magazine.

“We have no timetable, but referring to international practice, people can form a rough idea,” he said.

Meng from BNP Paribas said that major reforms will be on ice until a reshuffle of top leadership at the start of 2013. After that, however, Beijing could have a true surprise up its sleeve and move ahead quickly in opening the capital account.

“2020 seems to be a relatively conservative objective. We could easily see it happen earlier,” he said.

(Editing by Neil Fullick)

Analysis: China to world: yuan is for trade, not investment