Viewpoint: March of the Yuan against Dollar dominance

Global investors are showing growing interest in the Chinese Yuan as a possible alternative to the US Dollar, as the process of de-dollarization gains momentum. American experts acknowledge the lasting nature of the de-dollarization trend but maintain that despite its prevalence, there is currently no substitute for the US dollar, which remains a widely accepted and freely convertible currency, serving as the dominant reserve currency.

Last week, Treasury Secretary Janet Yellen emphasized the significant factors behind the widespread use of the US Dollar in trade. She highlighted the presence of robust and accessible capital markets, adherence to the rule of law, and the availability of extensive financial instruments as key reasons for its dominance.

In contrast to Treasury Secretary Janet Yellen's perspective, Andrei Kostin, Chairman of Russia's VTB Bank, expressed a different viewpoint in May. He anticipated that the Chinese Yuan has a strong potential to replace the US Dollar as the primary global reserve and settlement currency within the next decade. The differing opinions present a debate regarding which projection is more accurate.

When Did the Yuan Make the Cut?

The Chinese Yuan, also known as the Renminbi (RMB), became part of the International Monetary Fund's (IMF) Special Drawing Right (SDR) basket on October 1, 2016. This basket, which already consisted of the US Dollar, Euro, Japanese Yen, and British Pound, welcomed the inclusion of the Yuan.

Established by the IMF in 1969, the Special Drawing Right (SDR) serves as an international reserve asset to supplement the official reserves of member countries. The IMF regarded the inclusion of the Chinese Yuan in the SDR as a significant milestone in integrating the Chinese economy into the global financial system.

What's Holding it Back?

Critics argue that the Chinese Yuan (RMB) has yet to achieve widespread usage compared to the US Dollar. As of April 2022, the Dollar continues to dominate global currency transactions, being involved in 88 per cent of all trades, while the Yuan was used in only 7 per cent of transactions. 

Additionally, the Yuan's share of world foreign exchange reserves stood at less than 3 per cent by the end of 2022, whereas the Dollar and Euro accounted for 58 per cent and 20 per cent respectively.

In May, the Renminbi's global market share, according to the Society for Worldwide Interbank Financial Telecommunication (SWIFT), was just 2.5 per cent, significantly lower compared to the 43 per cent share held by the US Dollar or the 32 per cent share held by the Euro.

Western experts contend that China's capital controls and the limited transparency of its financial markets hinder the Yuan from attaining major global currency status. In contrast, Chinese experts argue that the Yuan's main purpose is to support the real economy, and relaxing controls could potentially result in speculative demand for the currency.

Will Yuan Claim Global Currency Status?

The Chinese Yuan has experienced significant growth in market share, jumping from 4 per cent in 2019 to 7 per cent in 2022, positioning itself as the fifth most traded currency, a significant improvement from its previous ranking of 35th in 2001. Furthermore, the RMB has now become the fifth-most-utilized currency for global payments as of April 2023, a notable rise from its previous position of 30th in 2011.

China is actively promoting the internationalization of the RMB. To facilitate cross-border payments in Yuan, the Cross-Border Interbank Payments System (CIPS) was established in 2015. In addition, China introduced the world's first crude oil futures contracts denominated in Yuan in 2018, enabling exporters to sell crude oil using the renminbi currency.

The People's Bank of China (PBOC) started working on a digital currency in 2014 and began testing it in four Chinese cities in April 2020: Shenzhen, Suzhou, Chengdu, and Xiongan. Furthermore, Alipay and Tencent Pay, both Chinese payment platforms, have gained significant popularity internationally.

Beijing's Belt and Road Initiative, which encompasses ambitious infrastructure projects and trade routes, has supported the global acceptance of the Chinese Yuan. Additionally, China acts as a lender by providing substantial loans to developing nations through its government and enterprises.

Yuan as Global Currency?

According to the IMF, the percentage of foreign exchange reserves held in US Dollars decreased from 72 per cent in 1999 to 59.8 per cent last year.

International observers believe that despite currently being behind the Dollar and the Euro, the Yuan has the potential to become a major currency due to a shifting geopolitical landscape. The recent restrictions imposed on Russia, including limited access to the global dollar-based payments system (SWIFT) and frozen central bank assets, have raised concerns among global actors about the Dollar's punitive capabilities.

The US Federal Reserve's substantial interest rate increases have resulted in the US Dollar becoming costly for foreign borrowers and those making payments in US Dollars for goods, raw materials, and other commodities. Before these rate hikes, Kristalina Georgieva, the managing director of the IMF, cautioned in January 2022 that such actions by the US could have adverse effects on the global economy, particularly on countries with significant amounts of debt denominated in US Dollars.

As the de-dollarization trend grew stronger, developing nations began to increasingly adopt the yuan or their own currencies as a response to what they perceived as the weaponization of the global financial system by Washington. They sought alternative or domestic payment systems to counter this effect.

Countries That Have Adopted China's Currency

After being barred from the Dollar-dominated financial system, Russia has transitioned to utilizing the Yuan for oil and natural gas payments. Recently, the Chinese currency surpassed the US Dollar as the most traded currency in Russia. Additionally, Russia's Finance Ministry has increased the allocation of both Yuan and gold in the country's national wealth fund.

Rosneft, a Russian company, issued renminbi-denominated bonds worth ¥15 billion in March 2023. With a coupon rate of 3.5 per cent per year, this issuance is considered the largest among corporate bonds currently in circulation in terms of Russian Rubles.

In response to its currency crisis and limited access to US Dollars, Argentina has turned to the Renminbi (RMB). The country has allowed commercial banks to open deposit accounts in the Chinese currency, as announced by the Argentine Central Bank. Additionally, Argentina is planning to issue securities in RMB and has already begun using the Chinese currency to pay for imports from China since April.

Earlier this year, Brazil and China reached an agreement to facilitate bilateral trade using their respective currencies, with trade volume amounting to approximately $163 billion annually. In April, it was announced that Bangladesh would be using the renminbi (RMB) to pay Russia for the construction of a nuclear power station. 

Furthermore, China's National Energy Giant CNOOC and France's Total Energies successfully concluded their first liquefied natural gas (LNG) deal settled in Yuan through the Shanghai Petroleum and Natural Gas Exchange in March.

In February, it was revealed that Baghdad intended to use the renminbi (RMB) to pay for private-sector imports from China, aiming to alleviate pressure on the Iraqi dinar. Similarly, TESCO, a British supermarket chain, opted to pay its Chinese suppliers in yuan during the same month.

What's Driving the Chinese Currency's Value Down?

Chinese media has acknowledged that although the Yuan has made significant strides in internationalization, its value has declined in comparison to the US Dollar. In the past week, the Chinese currency reached a seven-month low against the greenback, leading to speculation about potential intervention by the country's monetary authorities.

Earlier this week, the People's Bank of China (PBOC) provided clear instructions regarding the exchange rates of the Chinese currency. Additionally, Pan Gongsheng, who heads the State Administration of Foreign Exchange, was appointed as the chief of the Central Bank towards the end of last week.

While the depreciation of the Renminbi poses a significant challenge for the newly appointed PBOC chief, Chinese observers are confident that the yuan lacks a fundamental basis for a prolonged decline. The Global Times highlighted that as the de-dollarization trend continues, there has been a rise in the number of enterprises utilizing Renminbi for trade settlements. 

Increased liquidity has been injected into the global financial system to meet the growing demand for the Yuan, making the currency's fluctuations appear more foreseeable. The media anticipates further growth in the global share of the Renminbi.

The media outlet emphasized the importance of avoiding speculation and arbitrage in order to maintain stability and foster the internationalization of the yuan. While short-term fluctuations in the currency are considered normal, it is crucial to take measures that promote stability.

The author is a defence expert