Recent developments in the world’s financial markets indicate that China’s yuan is on track to assume the role of the world’s third reserve currency, after the US dollar and the euro.
The yuan-designated dim sum bonds are being issued not only in Hong Kong, where they were initially launched, but also in Singapore and now in London. A $320 million bond designated in the yuan was recently issued by HSBC in London, attracting an enthusiastic response. London is likely to become a key platform in the internationalisation of the Chinese currency. The total outstanding dim sum products in Hong Kong reached 292.86 billion yuan from only 200 million yuan when they were launched in 2009. The Indian government recently permitted IL&FS and IDBI Bank to raise $100 million each through the dim sum route in Hong Kong.
The dramatic rise in yuan-designated financial products parallels the rapidly growing proportion of China’s external trade, which is settled in Chinese currency. This has risen from seven per cent a year ago to about 11 per cent currently. China has announced that henceforth all entities trading with the country can settle accounts in the yuan, subject to some local conditions. Earlier, only some 60,000 China-based entities had been granted permits to avail of this facility. According to China’s Vice-Premier Wang Qishan, the target is to achieve a figure of 50 per cent by the end of 2013. This may prove ambitious, with analysts predicting one-third as a more likely figure. However, the rise in yuan-denominated trade implies a significant increase in the international demand for Chinese currency and yuan-based financial products.
A number of countries are now including yuan holdings as part of their international reserves, though this is still a modest figure. These include Malaysia, the Republic of Korea, the Philippines, Nigeria, Russia, Belarus and Mongolia. This list is likely to expand in the near future.
China has expanded currency swap arrangements with a growing number of countries. The total is now 17. In the recently held BRICS summit in New Delhi, the leaders agreed to encourage the use of their currencies for settling intra-BRICS trade transactions. Given the volume of China’s trade with the members of this grouping, there is every expectation that this will enhance the status of the yuan as an international currency.
The Chinese government recently announced that under its qualified foreign institutional investor scheme, foreign entities can invest in the Chinese securities market using offshore yuan. The cap under this scheme has been raised from $30 billion to $80 billion.
China has also been active in promoting a regional financial architecture in Asia that would establish its economic pre-eminence. It has taken a series of graduated steps in this direction. In my column titled “China and the Asian Monetary Union” (Business Standard, July 20, 2011), I had drawn attention to several developments taking place under the Chiang Mai Initiative Multilateralisation (CMIM). The CMIM brings the 10 Asean (or the Association of Southeast Asian Nations) countries together with China, Japan and the Republic of Korea. I had described the evolution of the CMIM as leading towards an Asian Monetary Fund, with China at its core. In April this year, the overall currency swap available under the CMIM was raised from $120 billion to $240 billion. It will still be necessary for a member country to have a parallel support programme with the International Monetary Fund (IMF) to be eligible to obtain supplementary funds from the CMIM. However, this amount has been raised from 20 per cent of the IMF loan to 40 per cent. Thus, the role of the CMIM as a crisis-prevention mechanism is steadily increasing.
It may also be noted that CMIM has put in place a precautionary line of credit to enable further balance of payments support to its members. It was also agreed that an Asean Infrastructure Fund would be set up to channel long-term investment to Asean projects, such as the ambitious Asean Connectivity Initiative. These, too, will create opportunities for China to emphasise its role as a key source of capital for the region.
Taken together, these recent developments give substance to China’s stated ambition of internationalising its currency and gain the status of a reserve currency rivalling the US dollar and the euro. The continuing uncertainties over these two established currencies are also creating a larger space for China and increasing the acceptability of its currency in the international financial markets.
I have argued that India should carefully assess the implications of these developments not only for India’s economic interests but also for their geopolitical impact. India lost an opportunity early on to become part of the Chiang Mai Initiative. It is now likely to be pushed to the margins in a region whose salience in our external economic relations continues to rise. It is unlikely that in the foreseeable future India’s global trade and investment profile would match China’s. However, should we establish a yuan market in India, become a centre for yuan-denominated financial products and use this to develop our own financial markets? Should our commercial entities be permitted to raise yuan funds to finance investment projects in India? Since China is a competitive source for infrastructure projects, whether in power or in telecom, should we attempt to work out a strategic economic partnership with China in our infrastructure sector? Could such a partnership be leveraged to promote a better political and security relationship?
I believe we should carefully examine and seek to answer these questions and formulate a coping strategy. China’s leaders are aiming to make the country’s currency fully convertible by 2015. The steps that are being taken currently all point in that direction. Even if China were to exercise caution in this regard and adopt a more graduated process, the direction and destination are no longer in doubt. When this happens, the overall global balance of power will shift even more dramatically eastwards than it appears today. The costs of our current political dysfunctionality and neglect of economic reforms and governance will be serious. Instead of emerging as a credible alternate pole of political and economic influence in Asia, we may be leaving ourselves no choice but to acquiesce in a China-dominated landscape.
The writer, a former foreign secretary, is chairman of RIS and a senior fellow at the Centre for Policy Research