Barely a week goes past without somebody predicting the imminent demise of the US Dollar, the world’s reserve currency. Such predictions are usually grounded more in geopolitics than economics. As China continues to grow and challenge US hegemony, the argument goes, so the Chinese Renminbi (RMB) will inevitably come to displace the greenback as the world’s currency of choice.
Phyllis Papadavid, Senior Research Advisor at the Asia House thinktank, is not one of those making that argument. However, in a recent paper, Papadavid examined the growing prominence of the renminbi in global trade. Perhaps the most striking finding in the paper is that the current growth trajectory of the RMB suggests that the currency could surpass the euro as a currency of trade in the next two years. What would this mean for global financial markets, and indeed global politics?
Papadavid told Disruption Banking that these trends should not come as a surprise and that it is important not to exaggerate the renminbi’s prominence. “Regionally, the yuan has been used increasingly over the past few years, particularly in emerging and developing countries,” Papadavid said. “Over the past decade in particular, it’s risen quite a bit in its usage, but it’s mostly been from a low base. It’s the growth that’s the most impressive factor because it’s still nowhere near the dominance of other currencies, such as the dollar or even other G3 currencies.”
What is driving this growth? Some countries are using the yuan as an alternative to the dollar to circumvent American sanctions and jurisdiction. Papadavid pointed out that the renminbi’s share of central bank foreign reserves is about two to three percent, but the Russian Central Bank holds up to a third of its reserves in RMB. But perhaps a more important factor in the rise of the renminbi is the emergence of the “petroyuan.”
Papadavid explained that, for trade in oil between China and the Middle East, the yuan is increasingly becoming the invoicing currency of choice. “The Middle East is pivoting to Asia,” Papadavid told Disruption Banking. “There is a trade pivot going on whereby both trade and investment ties between the Middle East and Asia are growing and there is demand for Middle Eastern oil in Asia.”
“There’s an element of that pivot driving the invoicing in China’s currency,” Papadavid added. She also noted that, for countries conducting oil trades, not using a “third currency” can help to minimise financial volatility.
“There’s a lot of literature around how invoicing in a third currency – so not a Middle Eastern currency and not as Asian currency, but a third currency like the euro or dollar – increases financial volatility. If you have a contract in dollars, and it’s a third reference currency rather than that of one of the two trading partners, you have more financial volatility than you would have done otherwise,” Papadavid said.
Particularly over the last few years, with high levels of volatility in foreign exchange markets, the yuan has also been perceived by some as a more stable currency. This is because of the strict controls the People’s Bank of China (PBOC) has in place to manage the currency, which can only trade within a narrow range of two percent above or below the fixed rate.
“In some sense, the peg does make the currency more attractive because it’s more or less being managed, and is less volatile,” Papadavid said. “But in another sense, it’s not realistic to expect that any currency could be managed for a long time, especially when the economy is open.”
“The PBOC has a very high level of reserves, of course, which enables them to have that policy in place. But ultimately, they’re going to have to consider becoming more flexible. The central bank governor recently said that they’re not going to intervene as much,” she added. “If you want to have a very global and healthy financial system, you need a big bond market and equity market. If you want to develop primary and secondary markets, and merge your offshore and onshore markets, you need the currency to be a flexible instrument.”
It certainly seems that all the conditions are in place for the yuan to continue growing. Digitalisation and the use of the e-yuan could further expedite its use, particularly in East Asia. The rise of the renminbi in oil deals and global trade will likely see the currency “continue to chip away at everyone else’s shares.”
But Papadavid doubts whether the yuan will ever challenge the dominance of the dollar – or even whether that is one of Beijing’s policy goals. “I think the goal of internationalisation is to bolster the renminbi and to make it an effectively functioning currency in investment and trade transactions. I don’t think dollar dominance is necessarily a problem or something to overcome if you’re a Chinese policymaker.”
“The internationalisation of a currency is really just bringing the functioning of the currency on par with the strength of the economy,” Papadavid said. “China is aligning the functioning of the currency with the importance of the Chinese economy.”
