Market Views: Could the RMB dislodge the US dollar as a reserve currency?
The internationalisation of the Chinese yuan (CNY or RMB) has opened up opportunities for asset classes such as Chinese bonds, but experts told AsianInvestor that there are still some challenges to overcome before the currency can rival the US dollar (USD).
The Chinese government has been working towards the internalisation of the RMB since the Great Financial Crisis, and has made some headway in that area.
In the first quarter of this year, central banks held $287.5 billion worth of RMB in official foreign exchange reserves, the highest level since the fourth quarter of 2016 and representing 2.45% of the total, according to a report published by People’s University of China on July 24. The yuan internationalisation index reached 5.02 at the end of 2020, a sharp increase of 54.2% from the previous year.
For the first half of this year, RMB appreciated by more than 1.2% against the US dollar, amid US dollar weakness against major currencies.
The Chinese government has also been developing a digital yuan, which is currently undergoing trials in several cities. Once launched, the digital currency is expected to hasten the process of RMB internationalisation.
However, experts told AsianInvestor that further capital liberalisation is needed in China to allow more convertibility of the CNY and improve flow in and out of the country.
AsianInvestor asked experts about whether the currency can replace the US dollar as a leading reserve currency, how RMB internationalisation could affect their investment portfolio, and which type of assets are favourable in the longer term.
The following responses have been edited for brevity and clarity.
Arthur Lau, co-head of emerging markets fixed income, head of Asia ex Japan fixed income
As China’s trade (exports and imports) continues to increase worldwide and its GDP will represent a much higher weighting in global GDP over time, we believe more demand for CNY is inevitable whether this is due to trade or transaction-related reasons, as well as being used as a reserve currency by various central banks.
Nevertheless, we do not think the growing importance of the CNY will threaten or even be a rival to the USD. As China still has capital controls in place and the CNY is not entirely fully and freely convertible internationally, we may need to see more capital liberalisation in China and further improvement in global settlement and clearing arrangements.
Relating to the investment perspective, we do think investors who currently focus on highly-rated sovereign types of assets should consider investing in RMB-denominated government bonds, which offer attractive risk-adjusted return alternatives over many negative and low yielding sovereign-related assets.
Benno Klingenberg-Timm, Asia Pacific head of global sovereign markets
UBS Asset Management
In our recent UBS Reserve Manager Survey (Survey) of close to 30 central banks, the long-term average target allocation to the Chinese currency has increased to 5.7% from 5% in 2020.
The inclusion of RMB as a reserve currency remains a marathon, not a sprint. We see central banks actively increasing their exposure in the next five to 10 years, with the RMB coming close to being regarded as an official reserve currency.
With the RMB gaining international standing and the opening of China’s onshore markets, investors should consider a strategic allocation to China bonds.
First of all, Chinese government bonds have the highest nominal yields among the 10 largest fixed income markets. Also, during periods of global market volatility, portfolios with exposure to RMB and Chinese bonds have demonstrated resilience. Thirdly, the inclusion of China bonds into more key global bond indices will put downward pressure on yields, further lifting international ownership in the onshore fixed income market.
Paul Sandhu, head of multi-assets quant solutions & client advisory, Asia Pacific
BNP Paribas Asset Management
Even since the end of 2019, the foreign exchange holding in RMB has increased about 27%. However, this is only around 2.45% of the global reserve currencies by the end of the first quarter of 2021, according to IMF data. The USD reserve on the other hand had declined from about 65% to around 60% in recent years, where this gap has been filled mostly by British sterling and Japanese yen. In the near future, it is a leap to expect that RMB will be able to challenge the USD as a global reserve currency.
[Because of] the attractive yield difference between China bonds and developed market bonds, China bonds have been popular among foreign investors. Foreign investment in China equity increased in recent years due to the inclusion of China A shares by the benchmark indices such as MSCI indices and the opening of Stock Connect. However, recent high volatility in China A-shares, particular due to regulations towards the technology sector may affect the flow into China over the short term.
The domestic authorities have taken important steps towards the liberalisation of the onshore RMB’s exchange rate over the last few years. However, the overall framework still falls short of a fully supply- and demand-driven RMB market, and failing to effectively fill this void may continue to raise concerns about the possibility of government control over the currency’s valuation.
Wim-Hein Pals, head of emerging markets equity team
In order to attract foreign money from global investors and multinational companies, China has been opening up its economy to the global financial capital markets, including the global currency markets. It will continue to loosen restrictions that are currently in place as far as the convertibility of its RMB is concerned.
So, in the long term, the CNY is going to challenge the USD as a reserve currency, since the “gradual opening” process of its currency trading means more foreign demand for its renminbi. As a result, the most likely development route for the CNY is that of a gradual appreciation versus the USD and other OECD currencies.
A stronger currency results in less inflationary pressures and more spending power among the Chinese population. With the above in mind, every investment portfolio should very much be tilted towards domestic consumption companies in China rather than its export sectors.
Kunjal Gala, emerging markets portfolio manager, international business
We do not think that CNY will challenge the USD as a reserve currency anytime soon. To challenge the US, China needs to open up its capital account which is unlikely as China is a centralised economy and Beijing will not be willing to lose control over the flow of money in and out of its borders.
With everything else happening in China, disputes with the US, Japan, Australia, Taiwan, India, Southeast Asia over territory or other aspects, it is not possible for these countries to accept the CNY as a reserve currency for obvious reasons.