While the yuan’s internationalization is making rapid progress, it will have to expand much further to fully challenge the dollar’s dominance. That will require it to acquire three critical functions: First, more international contracts could be denominated and settled in yuan. Second, more countries could shift their reserve holdings to the yuan.
The Yuan’s Journey To Globalization
China is determined to make the Yuan Global currency, one that can challenge the dollar’s dominance as a reserve and transaction currency. But it faces major challenges, including capital controls and its commitment to exchange rate stability. As for transactional functions, Beijing has gradually opened up the yuan’s use internationally by relaxing rules around quotas and lock-up periods on foreign investors. As a result, the yuan’s share of international payments rose to nearly 3% in July, according to SWIFT data, pulling down second-tier currencies like the pound.
Since the Ukraine conflict, Russia has increased its use of yuan, and other countries are following suit to lessen their dependence on the dollar. Bangladesh, for example, is paying Russia for coal in yuan, and oil companies in Venezuela are issuing bonds denominated in yuan. Even Tesco, the British retailer, wants to accept yuan for its Chinese imports. However, these developments do not add up to a true challenge to the dollar’s primacy, because the yuan is still tied to the dollar in terms of foreign reserves.
Yuan’s Role As A Global Currency
While the yuan has made significant progress in internationalizing, it remains well short of challenging the dollar’s status as a global reserve currency and the standard for trade contracts and settlements. The yuan’s share of global foreign exchange reserves held by central banks stood at less than 3% last year, according to Cofer, which tracks the world’s most widely used currencies. This is partly because of Beijing’s steadfast refusal to allow the free flow of capital into and out of China, which gives it a tight grip on domestic economic policy.
Nonetheless, the yuan’s gradual rise has chipped away at the share of second-tier currencies such as the pound, but not the dollar’s. And the war in Ukraine has prompted many countries to open their markets to yuan-denominated commodities, further enhancing its potential role as a world trading currency. ING’s Green predicts the yuan’s global prominence will accelerate as Beijing cements yuan-based trade relationships with additional countries.
Yuan’s Potential As A Global Reserve Currency
Beijing has been promoting its currency’s role as an international reserve asset. But its efforts have been hampered by political concerns and the need to retain control over capital flows. At the moment, only about two percent of global import and export contracts are denominated in yuan or settled with it. That’s up from five or ten years ago, but far short of Beijing’s goal.
The yuan’s position as a global reserve currency will improve, but only slowly. Its value may rise faster than the yen and sterling (which are bundled together in the “others” category of Cofer’s data), but it will still trail the US dollar. Increased foreign investment into Chinese markets will drive yuan usage, Morgan Stanley says, helping it reach between 5% and 10% of global reserves by 2030. That would be a significant advance, but it will still put the yuan well behind the yen and the euro. China’s political interests also make it unlikely that it will allow the kinds of open financial markets needed for a new world reserve currency to thrive.
Yuan’s Role As A Payment Medium
In domestic retail transactions, digital yuan (e-CNY) is being distributed through private fintech firms such as Alibaba’s Alipay and Tencent’s WeChat Pay. These private companies are leveraging their large user bases to promote the e-CNY and to encourage consumers to adopt the new system. In trade finance, the Yuan Global has also been gaining ground and now accounts for 5.8% of global payments, according to SWIFT. This has boosted the yuan’s share of traffic for letters of credit, a form of short-term financing that facilitates trade.
As China moves to build cross-border payment systems based on the yuan, it seeks to reduce its reliance on US dollars and make it less vulnerable to US monetary policy adjustments and financial sanctions. However, China’s capital controls and limited transparency in its financial markets prevent it from achieving the global standing required for the yuan to become a major reserve currency. This could change as the yuan becomes more widely available for international investment.
Conclusion
The pace of yuan internationalization is picking up as China seeks to reap the benefits of de-dollarization: less need to accumulate foreign-currency reserves, lower cross-border transaction costs, and increased political leverage. But China’s capital controls and confined financial markets limit its appeal as a global currency.
