MNI INTERVIEW: Yuan To Emerge As Regional Reserve Currency

Demand for the yuan in Asia and Belt and Road Initiative (BRI) countries is likely to rise as the U.S. dollar-dominated monetary system declines and the world moves toward a system of regional reserve currencies, requiring China’s central bank to further liberalise the capital account and open its financial markets, a prominent Chinese economist told MNI.

Given China’s deepening economic and trade ties with Asian and Belt and Road Initiative countries, the yuan is likely to emerge as the most viable candidate to be the region’s dominant currency as the dollar is undermined by the U.S.'s retreat from globalisation, said Cao Yuanzheng, former chief economist of the Bank of China.

The relationship between the yuan and the dollar is central to the current bout of trade tensions with the U.S., which wants a global rebalancing to revalue the Chinese currency against the greenback. Cao, who helped design and run China’s yuan internationalisation plan since 2008 as an advisor to the State Council and as an official at BOC and BOCI China, said one way to strengthen the yuan’s role would be to convert part of the USD240 billion foreign exchange reserve pool under the Chiang Mai Initiative Multilateralisation (CMIM) into yuan.

ASEAN, China, Japan and South Korea created the initiative to provide emergency liquidity through bilateral or multilateral swaps in 2009 following the Asian financial crisis in 2000 and doubled its size in 2021. (See MNI INTERVIEW: Chinese Firms Should Hedge Dollar Risk-Guan Tao)

Expanding the yuan’s use in the CMIM would boost its presence in central banks’ reserve portfolios, Cao said. In the meantime, China should also accelerate the development of an Asian bond market hub in Hong Kong to encourage the yuan's use in sovereign debt issuance around the region, he said.

BELT AND ROAD

Beyond Asia, Belt and Road partner countries will be key destinations for yuan cross-border investment and settlement, said Cao, noting that BRI economies already account for over 50% of China’s total trade, while Chinese outbound investment in these nations has grown at an average annual rate of 28% over the past three years, far exceeding the 10% pace of growth in total outbound investment. 

Stable yuan flows into BRI nations’ capital accounts would increase the liquidity of the currency overseas and drive its use, Cao said, pointing to the example of the U.S. Marshall Plan that laid the groundwork for the dollar’s global dominance after the Second World War. 

For China, however, this path is fraught with challenges.As an early advocate of yuan internationalisation, Cao argued that full convertibility, deeper financial openness, and the development of a persistent deficit in China’s international balance of payments are all necessary – but each presents formidable challenges. (See MNI INTERVIEW: China To Facilitate O/S Investors-PBOC Official)

It would also be necessary for the People’s Bank of China to expedite the development of a well-anchored sovereign bond yield curve in a bid to provide pricing benchmarks for financial products, which would help China’s interest rates align with global markets and permit the PBOC to evolve into a regional central bank, he said.