China is the world’s largest manufacturing economy, the world’s largest exporter nation, and the world’s second largest economy. With its huge and still growing financial footprint, the financial world is eyeing the Chinese yuan as a global currency and viable investment. Can the yuan ever serve as a potential alternative to the U.S. dollar? Analysts following the Chinese currency think that now may be the right time to invest in the Chinese yuan.
The People’s Bank of China, the country’s monetary authority, issues the Chinese yuan (CNY), also known as the renminbi (RMB or the people’s currency). The yuan follows a floating exchange rate policy, with the central bank having a decisive control over its valuation against other currencies.
The biggest challenges to the Chinese yuan’s popularity and valuation are its reach and circulation. Remember how the euro became very popular soon after its introduction across multiple European Union nations? Like the euro, the Chinese yuan is well placed to grow in popularity and become stronger. Here are a few developments which indicate the yuan is a good investment now and will likely improve in years to come:
- China continues to grow as a financial powerhouse and all signs point towards increasing dominance. Countries have traditionally conducted international trade in U.S. dollars even if neither trading partner used dollars as their official currency. Increasingly, some countries are now switching to transacting directly in Chinese yuan for trading with China. This will strengthen the currency as a whole, based on global demand.
- SWIFT, the global leader in processing payment related messages, reported a significant rise in transactions occurring in Chinese yuan. According to a SWIFT report, “More than 1,050 financial institutions in over 90 countries are already doing business in the Chinese currency.” These developments indicate the growing popularity of the Chinese yuan. (For related reading see How The SWIFT System Works)
- FinancialPost estimates that “By 2015, about 30% of China’s cross-border trade will be settled in the renminbi.” In addition, says FinancialPost, “From 900 financial institutions conducting business in RMB in 2011, the number is now more than 10,000.” With such growth, the yuan has the potential to become a global currency with strong valuations.
- Developments in China have been positive. It recently opened up to private banking which is expected to cater to mid- and small-sized businesses and individuals who have so far remained outside of the global financial purview (see related Will “Internet-Only” Banks Change Chinese Banking?). Such developments are expected to accelerate economic activity to new level, increasing the demand and the valuations for yuan.
- A large number of multinational corporations are doing business in China which include those with financing needs for themselves and the end customers. For example, automakers like BMW do not just manufacture and sell cars in China, they also finance car purchases in Chinese yuan. The more business improves with such financing needs, the more economic growth the nation will have and the better an investment the currency will be.
- Singapore, Hong Kong, and Taipei have been well established as authorized offshore settlement centers to promote and facilitate yuan transactions and to issue yuan-denominated bonds. Recently, the Chinese central bank also made agreements with Frankfurt and London enabling them become authorized yuan payment centers. Effectively, these European centers will become yuan trading platforms, offering a wider reach for the yuan and making it a stronger popular currency.
- China allowed the sale of yuan-denominated bonds in 2007, a move which helped the currency gain popularity. Nicknamed dim sum bonds, the demand for these debt issues has exceeded its supply. Riding high on the wave of popularity of Chinese yuan, not just the governments, but even large corporations (like British Petroleum, Caterpillar, and Volkswagen) are offering the dim sum bonds. Beginning in 2008, the yuan-denominated debt market doubled in size each year.
- China is a net creditor to the United States and holds strong portions of U.S. treasury securities (read more about this in The Reasons Why China Buys U.S. Treasury Bonds). It has a high quantity of forex and gold reserves, which will eventually improve its credit worthiness. Similarly, it is known to move smartly on building self sufficiency on energy front. (Related Why Is China Stockpiling Millions of Barrels of Oil?)
The Bottom Line
China has been a closed-door, state-controlled economy and general perceptions are that it will take a lot to achieve the internationalization of Chinese currency. The government is very cautious about any new development and treads carefully. The central government controls exchange rates and interest rates strictly. Yet China has demonstrated significant adaptability and the potential to become a world superpower and financial giant. The Chinese yuan is good investment now with great growth potential in the future. Once China opens up and accelerates much-needed reforms, the Chinese yuan will become an even stronger currency.