China's long-term plans for its currency

The role of yuan internationalisation in reshaping the global order

Tracking the trajectory of the internationalisation of the Chinese currency, renminbi (RMB), is a useful pointer to China’s strategy for achieving geopolitical pre-eminence. In my earlier column on the subject, “Renminbi’s growing influence” (Business Standard, June 13, 2017), I had argued that despite a significant stall in 2015 and early 2016, in response to stock market volatility and large capital outflows, measures to establish the RMB as an international reserve currency through a series of graduated steps, had resumed. China has been leveraging its sheer economic weight as the world’s second-largest economy and largest trading power (accounting for 14 per cent of global trade), to raise its profile in the world financial markets, challenging both West-led institutions as well as processes.

An important recent development has been the inclusion of 222 China A shares in the Morgan Stanley Capital International (MSCI) Emerging Market Index in June 2017 but which will come into effect in June this year. Although in the initial phase the Chinese shares will enjoy a modest 0.72 per cent weightage in the index, this will in all likelihood grow progressively as Chinese capital markets continue to open up and put in place a more transparent legal and regulatory framework. There is likely to be an inflow of about $12.5 billion post-inclusion into Chinese assets but once there is full weightage accorded, Chinese stocks could well constitute 18 per cent of the total weight in the index. This would mean that most international passive funds which base their allocations on the MSCI index would greatly increase their exposure to Chinese securities. It is estimated that this may lead to a massive $1.5 trillion of such funds to enter the Chinese market. Managing what is being called the “largest asset transition in our lifetime” is likely to transform the global financial market and its architecture. This will impact the flow of such funds to other emerging markets such as India and it would be prudent to anticipate and put in place coping strategies.

International access to China’s security market continues to be liberalised through increased quotas under the various portfolio investment schemes. However, more important in this regard are the Hong Kong-Shanghai and Hong Kong-Shenzhen Connect schemes which provide reciprocal access to stock markets. The daily quota under the Hong Kong-Shanghai Connect is 10 billion yuans a day and under the Hong Kong-Shenzhen connect it is 12 billion yuans a day. The holding period for equities has now been reduced from 12 to three months, demonstrating an enhanced tolerance of volatility.

A large, liquid and stable international bond market is an essential prerequisite to the RMB’s ambitions to become a credible international currency. In this context, one must note the growing importance of the Chinese bond market, which is the third-largest in the world but only 2.4 per cent are held by external entities. The inter-bank bond market in China has been opened to foreign entities and hedging operations, though carefully regulated, will now be permitted to manage risk. China also established the Bond Connect mechanism in May 2017, which will simplify access to Chinese bonds directly from Hong Kong, without having to open custody and bank accounts for this purpose in China. It is reported that a similar Bond Connect with London may be in the pipeline. 

Illustration by Binay Sinha

China is still experimenting with various financial liberalisation policies. It had set up a pilot financial free trade zone (FTZ) in Shanghai in 2013 and the created three more in 2015 in Tianjin, Fujian and Guangdong. Entities registered under these zones enjoy full currency convertibility. A negative list approach enables businesses to be set up in non-prohibited sectors with minimum red tape. In April 2017, seven new FTZs were announced, five of which are in inland provinces. These are linked to the ambitious Belt and Road Initiative (BRI) under which the inland provinces will constitute an economic corridor linking with neighbouring central Asian countries. For example, the proposed FTZ in Chengdu, Sichuan, will serve as a BRI logistics and cargo hub with a large scale bonded warehouse and associated financial, banking and insurance facilities. Promoting the RMB as an international currency is an explicit component of BRI. A Chinese government report states that BRI strategy and RMB internationalisation are China’s two major national development strategies proposed in the new millennium and are “mutually reinforcing”.

In the recent past, China’s electronic payment and mobile payment have seen rapid development and this too will create a new platform for RMB internationalisation. China already constitutes 37 per cent of the global payments market which was worth $21.6 trillion. The China Union Pay credit card has already become the largest bank card group in the world and 41 million merchants in 160 countries accept it. However, it is held overwhelmingly by the Chinese with only 0.5 per cent being international clients. The mobile payment market in China, led by Alibaba and WeChat, is worth $12.7 trillion, far ahead of any other country in the world. Alipay, the Alibaba-owned payment system, is rapidly acquiring an international profile and owns a 40 per cent stake in India’s Paytm. On the back of large domestic volumes, China’s electronic and mobile payments systems will steadily establish an international presence.

Chinese policymakers want to establish a mature financial centre in China, constituting a comprehensive market for pricing and trading of the RMB. The trajectory they envisage would graduate from short-term money market to mid-term bond market and then to a long-term multi-level equity market. Currently only 2 per cent of global trade and 1.4 per cent of global investor’s portfolios are RMB based. So there is a long way to go but the trajectory is clear. China wants to align its global financial profile with its already large economic and security profile. Taken together they will feed into China’s quest for geopolitical dominance.

A China-dominated global financial order is likely to be different than the familiar US-led one. It will be more state-controlled and regulated and less tolerant of volatility. According to one analyst, “…it remains possible that RMB internationalisation will transform the global financial landscape in deeply qualitative as well as purely quantitative ways ushering in an era of more illiberal state-managed monetary relations”.

These developments will impact India’s economic prospects and position in the emerging global order and need a strategic response but one fails to discern any focus on them.

The writer is a former foreign secretary and currently senior fellow, CPR

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