Great powers have great currencies.
– Robert Mundell, Nobel Laureate
Though the Chinese are normally only inspired by Confucian thoughts and the teachings of Sun Tzu, for once they seem to have adopted an American idea of converting crisis into an opportunity, propagated by the likes of Rahm Emanuel who has famously commented; “you never let a serious crisis go to waste. And what I mean by that it’s an opportunity to do things you think you could not do before.” The current Coronavirus pandemic is too precious a crisis to be wasted by the Chinese. As US, Europe and Russia battle the virus; the Chinese are busy asserting themselves and expanding their global footprint. They have increased the funding to WHO by USD 30 million, donated medical supplies (albeit dubious) to Africa and Europe, violated the territorial sovereignty of Vietnam by naming 80 islands and other geographical features in the South China Sea, while Chinese state media and diplomats sing an aggressive and jingoistic tone.
However, away from the headlines of border clashes in the high Himalayas and undiplomatic Chinese diplomats, China is making quiet but sustained efforts to reduce the dollar dominance in international trade and prop up Renminbi (RMB) as an alternative currency. The Renminbi is also known as the Chinese Yuan (CNY), and in fact, Yuan is the more popular usage. Towards pushing the Yuan, China is adopting a multi-pronged approach, operationalising its sovereign digital currency, providing aid in Yuan to Coronavirus hit nations, cajoling more countries to trade in Yuan, besides making their currency trading easy and attractive.
During the current pandemic, the relative stability of the Yuan has enhanced the appeal of a Chinese digital currency. In end-April 2020, China tested DCEP (Digital Currency and Electronic Payment) as part of the development of a Yuan-based trade settlement system. China is creating DCEP as an alternate to the dollar-dominated settlement system called SWIFT (Society for Worldwide Interbank Financial Telecommunications). Chinese media reports that government employees will soon begin receiving a portion of their subsidies in the digital currency, issued to them by state-owned banks. The Chinese government is also considering the use of the digital currency during the Beijing 2022 Winter Olympics. China’s digital currency could emerge as a functional alternative to dollar settlement, though in the initial years it is likely that both SWIFT and DCEP systems shall co-exist.
China owns USD 1.07 trillion in US treasury securities, more than any other foreign country. It is about 5 percent of the USD 23 trillion US national debt. A sudden decline in the value of USD shall harm China as well, and therefore China is moving slowly. The Yuan has been gaining ground. In November 2015, the IMF awarded the Yuan the status of a reserve currency. In October 2016, the IMF added Yuan to its Special Drawing Rights basket. This basket earlier included only the Euro, Japanese Yen, British Pound, and USD. More than 60 central banks or monetary authorities around the world now include the Yuan in their foreign exchange reserves. The Chinese are making it easier to trade Yuan in the global foreign exchange markets. In 2019, more than USD 285 billion worth of Yuan was traded in the forex market. Yuan has now become the fifth most used currency in global payments, after the USD, British Pound, Japanese Yen and Canadian Dollar.
China’s current five-year plan (2016 – 2020) explicitly prioritises the goal of improving Yuan convertibility and mentions increased international use of the currency as a likely consequence. Successful internationalisation of Yuan would offer lower borrowing costs and reduced exchange rate risk to China. Following this plan, China has established many bilateral currency swap agreements, which provide countries with access to foreign currency and reduce the risk of exchange rate fluctuations. In a massive bid to push Yuan, between January 2009 and March 2020, China signed currency swap agreements with a total of 33 other governments. More agreements are being worked out by China during the current pandemic, with indirect hints about the policy instability of the Trump administration. Many other actions are in hand. The Dim sum bonds now allow investors to purchase Yuan-denominated assets outside of mainland China. The inward and outward foreign direct investment of China is allowed to be cleared in Yuan. China has even started permitting Yuan settlements outside of mainland China.
A Brexit-hit Europe seems to be the focus of China in its efforts to replace the US dollar. China has set up many market access and trading infrastructure schemes in Europe, making it the largest Yuan market outside of Hong Kong. London has been established as the biggest Yuan trading hub outside of China while Paris, Frankfurt and Luxembourg have significant roles in the Yuan market. There are plans to launch Frankfurt-Shanghai Stock connect scheme after the Coronavirus pandemic stabilises. The People’s Bank of China has set up Yuan clearing banks in 25 major countries, including US, UK, Singapore, Germany, France, South Korea, Japan and Russia, in an attempt to globalize their currency. As of now, 31 institutions are directly participating in the Yuan Cross-Border Interbank Payment System (CIPS), while 847 are indirectly participating.
China’s aid mandate under the remit of China International Development Cooperation Agency, created in March 2018 its focus on developing countries, consists of grants and interest-free loans, concessional government loans and multilateral assistance. In the current crisis, the Chinese aid is being given in Yuan to many countries, indirectly increasing the trading of their currency in the global forex markets. The one million Yuan donation by Huawei to South Africa was in the Chinese currency, as many others aid packages announced by China in Africa.
Pushing the Chinese currency for oil trading seems to be another focus area. Currently almost all oil trading is carried out in USD, therefore commonly referred as Petro-dollars. China plans to counter by a ‘Petro-Yuan’. Towards this, it has established oil futures, tradable in Yuan, on the Shanghai International Energy Exchange (SINE), a branch of the Shanghai Futures Exchange. It has allowed foreign traders to participate in the market – a first for Shanghai commodities futures. Beijing has also exempted taxes on foreigners’ transfer and brokerage income in an effort to lure global capital into the Yuan-denominated oil futures.
An international Yuan would allow China to play power-politics with Washington. Replacement of USD is however far away. Before the Yuan can become a global currency, it must first be successful as a reserve currency. It should be easily used to price international contracts while all central banks should hold significant amounts of Yuan as part of their foreign exchange reserves. However, the currency markets, apart from the strength of the economy, work on trust factor. In spite of the battering the US economy has taken in the current pandemic, the trust factor in US is much higher as compared to China. US enjoys greater transparency in their financial markets and a relatively stable monetary policy. On the other hand, China is always worried about stability – from Hong Kong to Tibet – and thus Beijing maintains tight capital controls to buffer the Chinese economy. These restrictions inhibit the free movement of Yuan, making it unattractive as an international currency. For India, an international currency market dominated by USD is still a better bet, as China is known to use all available means to gain an upper hand in any conflict, and currency manipulation by China can never be ruled out.
Author: Col Shailender Arya
The Author is an alumnus of RIMC, Dehradun and NDA, Khadakvasla. He has served as GSO 2 of a mountain artillery brigade on the Line of Control, a company commander with Assam Rifles in Nagaland and as a Staff Officer with the United Nations. He is an MSc in Weapon Technology from Poona University and an MSc in Defence and Strategic Studies from Madras University. He has served as a GSO 1 (Operations) of a newly raised AR Sector HQ in a counter-insurgency environment in South Manipur and commanded an artillery regiment on the Line of Control in J and K. He is presently posted in the faculty at DSSC, Wellington.