Could The Yuan Renminbi (CNY) Become A Reserve Currency?

As an industrial superpower, China has taken steps to ensure that its domestic form of money, the yuan renminbi (CNY) or Chinese renminbi (RMB), is in line to secure reserve currency status.

Through extensive economic reform and adoption of policies promoting the globalisation of its financial markets, China has advanced the CNY via internationalization. Offering foreign investors access to its markets, as well as modifying protectionist economic policies, are two issues central to the CNY securing reserve currency status.

The Yuan Renminbi (CNY) And China's Acceptance Into The WTO

Beginning with its acceptance into the World Trade Organisation (WTO) in December 2001, China began the process of integrating its enormous consumer markets and labour pool into the global economy.

Although China's place in the WTO was met with extensive debate over the nature of the nation's official economic policies, negotiators granted membership following 15 years of voracious talks. By gaining acceptance into the WTO, China began its transition from being one of the most influential emerging markets to an economic superpower.

Since becoming a member of the WTO, rapid economic growth has drawn the attention of investors and economists the world over. Accordingly, the CNY's role as an international currency has grown dramatically with the nation ranking number-one globally in terms of gross domestic product (GDP), labour force and exports.

Appreciation And Devaluation

In lockstep with the robust economic performance, valuations of the CNY have appreciated significantly. For the period of 2001 to 2018, the exchange rate of CNY to GBP dropped from 13 to 8.7. This is a substantial appreciation for China's yuan, driven by enhanced participation and liquidity.

Although there was an appreciation of more than 30%, many of China's trading partners (including leading export destinations South Korea, Japan and the United States) were openly critical of monetary policy decisions pertaining to the CNY. Periodic devaluations by the People's Bank of China (PBoC) in Beijing were viewed as creating an unfair trade advantage for Chinese exports.

Equities sell-offs in the Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange (SZSE) related to the currency devaluations were halted by the Chinese government. Both actions drew criticism from the international financial community over China practicing a "protectionist" agenda toward their financial system.^[3]

PBoC Abandons USD Peg

In order to address these ongoing concerns, the PBoC abandoned a peg of the CNY to the U.S. dollar. In its place, a fixed relationship to a basket of currencies known as the China Foreign Exchange Trade System (CFETS) RMB Index became the benchmark for CNY valuations.^[4] Essentially, the CFETS RMB Index was a viable proxy of Chinese currency.

Using the CFETS RMB Index as a reference, the CNY is permitted by the PBoC to trade within a specified band of the baseline index value. This serves as a reference for inflationary pressures as well as a relative global valuation. Under this arrangement, the PBoC enacts a "managed float" policy toward the CNY.

While not truly valued by the open market, the CNY's relationship to the CFETS RMB Index is widely viewed as an important step in the currency eventually becoming "free floating." While not yet a reality, abandoning the index will have a major impact on international transactions.

Devaluation, Global Impact And Intense Scrutiny

With a literal meaning of "people's money," the yuan renminbi has existed in a largely isolated capacity for decades. Commonly referred to as simply the yuan (CNY), renminbi (RMB), or both, China's currency and adopted monetary policies are a hotly debated topic. Citing the practice of periodic devaluation of the CNY by the PBoC, detractors have labelled China as an active "currency manipulator" in order to gain unfair advantages in the export sector.^[5]

2015 Devaluation

One of the most criticised actions of the PBoC took place in August 2015 when the CNY was abruptly devalued by 4.7% in one week.^[6] Global equities and related currencies in the Asia-Pacific region lost considerable value on the sudden move. The Indonesian rupiah (IDR) and Malaysian ringgit (MYR) hit 17-year lows, while the Australian (AUD) and New Zealand (NZD) dollars each plummeted to six-year lows.

In addition, businesses tied to the region, such as automaker BMW and luxury goods maker Coach lost more than 3.5% of their total market share.^[7] Both domestic and foreign investors were left frustrated by the PBoC's move as asset prices plummeted.

International Criticism

Such swift and aggressive monetary policy has prompted much criticism from international trade partners. Tariff restructuring and challenges to China's membership to the WTO are recurring themes from many global superpowers.

Perhaps the most notable came from President Donald Trump on the 2016 campaign trail. Strong rhetoric threatening to officially label China a "currency manipulator" in the wake of PBoC devaluation policies was a central theme of the 2016 campaign. As of press time, the U.S. Treasury Office has not declared China a "currency manipulator" or enacted further penalties addressing China's monetary policies.^[8]

Is The Chinese Yuan Renminbi Already A Reserve Currency?

A reserve currency is defined as being a form of money that is held by both governments and institutional entities as part of their strategic foreign capital reserves. Reserve currencies are used to manage global systemic risk as well as to promote the pricing stability of goods and services.

In 2016, China took a major step toward the CNY becoming a featured player in the world's monetary system. Through earning a place among the International Monetary Fund's (IMF) basket of international reserve currencies, the CNY was officially recognised as globally prominent.^[9]

In addition, for the first time since the 1999 launch of the euro, the IMF decided to designate a new foreign currency to its Special Drawing Rights (SDR) pool. The CNY joined the U.S. dollar (USD), euro (EUR), Japanese yen (JPY) and British pound sterling (GBP) as the only denominations of money that may be used for IMF international loans.

Most Common Foreign Reserves

According to IMF statistics, the following are the most common foreign exchange reserves held by central banks around the world^[10]:

While several monies have been bestowed reserve status by the IMF and officially included in the SDR basket, the primary reserve currency is the U.S. dollar. Stemming from the Bretton Woods Accords in 1944, the USD has served as the backing for many foreign currencies and been an integral part of the world monetary system for more than 70 years. It is also a common denomination of digital currency assets such as Bitcoin, Ethereum and Ripple.

However, the global economic climate is always changing. In the event that central banks and sovereign governments elect to hold CNY inflows instead of the U.S. dollar, many asset classes may become valued in terms of CNY. An example of this phenomenon is the advent of a futures contract that prices oil in terms of CNY per barrel known as the "petroyuan." It is scheduled for launch in 2018 on the Shanghai Futures Exchange (SHFE) and will serve as Asia's premier benchmark for crude oil valuation.^[11]

Depending on acceptance and interest, the petroyuan may eventually rival oil markets in New York and London. In the event that its launch is a success, the petroyuan may be the first in a broad spectrum of international commodities to be valued in CNY.

Summary

Although the CNY is already a minor reserve currency in the eyes of the IMF, many in the financial industry are optimistic about future prospects. While the transition may be far down the road, sentiment toward the CNY eventually overtaking the U.S. dollar as the world's dominant currency is positive. Due to China's explosive economic growth combined with the lagging performance of the USD, global reserve levels of the CNY are projected to approach those of the Japanese yen and British pound in coming decades.^[12]

It is important to remember that a transition from the U.S. dollar to yuan renminbi as the global benchmark for value will take time. As of the 2016 Bank of International Settlements (BIS) Triennial Report, the CNY is involved in only 4% of aggregate daily forex turnover, ranking eighth. In comparison, 87.6% of daily forex turnover involves the USD.^[13]

In order for the CNY to become the primary global reserve currency, concerns over protectionist policy must subside as well as increased international accessibility to China's capital markets. While it is possible that the CNY may replace the USD as the defacto reference of economic prosperity, the passing of the baton may have an extensive timeline.