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And the forthcoming Communist Party congress is unlikely to kick-start it
ON OCTOBER 18TH, President Xi Jinping will preside in Beijing over the most
important political event in five years. At the Communist Party s 19th congress
much will be made of the triumphs achieved in nearly four decades of reform and
opening up. So expect a glossing over of one part of that process where
progress has largely stalled: the internationalisation of China s currency,
the yuan.
This seems odd. Just a year ago, the yuan became the fifth currency in the
basket that forms the IMF s Special Drawing Right (SDR). This marked, in the
words of Zhou Xiaochuan, China s central-bank governor, in a recent interview
with Caijing, a financial magazine, historic progress . Symbolically, China s
monetary system had been awarded the IMF s seal of approval. A further boost to
prestige was the announcement in June this year that some Chinese shares would
be included in two stockmarket benchmarks from MSCI.
Yet the yuan s international reach has in fact fallen in the past two years. It
has regained its ranking as the world s fifth most active for international
payments, after slipping to sixth in 2016. But its share of this market has
slipped from 2.8% in August 2015 to 1.9% now (see chart). Use of the yuan in
global bond markets over this period has fallen by half, as companies have
instead raised funds within China. In Hong Kong, the largest offshore market,
yuan deposits have plunged by 47% from their peak in December 2014. Of the
foreign-exchange reserves held by the world s governments, just 1.1% are in
yuan, compared with 64% for the dollar.
The constraints on the internationalisation of the currency are largely
self-imposed and in many cases predated admission to the SDR. A minor
devaluation of the yuan in August 2015, intended to make the currency more
flexible, was botched. This led to speculation about further falls in the yuan
s value, and forced the central bank to tighten capital controls and spend
foreign-exchange reserves to prop it up.
Since January this year, China s reserves have been growing again. But
stringent capital controls remain in place. In his interview Mr Zhou called for
a renewed drive to free up China s financial system, citing a troika of
targets: increased foreign trade and investment; a more market-based exchange
rate; and a relaxation of capital controls. He said there was a time window
for this. If missed, the cost of reform would be higher in the future.
Few observers, however, take Mr Zhou s comments as official policy. In office
since 2002, he is expected to be replaced next year. He represents one side of
a continuing debate. In September two capital-control rules were indeed eased,
but foreign traders tended to share the view of Mitul Kotecha of Barclays, that
the move was purely cosmetic. In the words of Eswar Prasad, an economist at
Cornell University and author of Gaining Currency , a book about the yuan,
what the government giveth, the government can taketh away. Most foreign
investors are all too aware of that.
So the currency s international advance is unlikely to resume soon. More likely
is a gradual opening of yuan markets. One avenue is to standardise systems such
as the China International Payment System, which processes cross-border
payments. Another is to expand the Bond Connect and Stock Connect programmes
that link Chinese markets to Hong Kong. A third involves China s intense
diplomatic drive to push its Belt and Road Initiative , involving massive
investments in infrastructure to boost transport, trade and investment links
between China and Central Asia, Europe and Africa.
However, David Woo of Bank of America Merrill Lynch argues that none of this is
likely to lead to a big surge in foreign holdings of Chinese financial assets.
That will depend on the liberalising measures Mr Zhou is advocating, as indeed
does the future shape of the Chinese economy. There isn t a single country,
Mr Zhou argued, that can achieve an open economy with strict foreign-exchange
controls.
But his apparent belief that measures already taken, such as joining the SDR
basket, have set the yuan on a remorseless path towards internationalisation
has been contradicted by the experience of the past two years. The party s
watchword remains stability . And whatever the benefits of capital-account
liberalisation, it would bring a measure of unpredictability. In a battle
between openness and control, Mr Xi is likely to favour control.