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New capital controls lead to doubt, especially over hopes of forcing economic reform
Back in October 2015, as then prime minister David Cameron welcomed President Xi Jinping to the UK, China’s central bank issued one-year bills in London’s offshore renminbi debt market. The move was viewed as cementing London’s status as the centre of renminbi business outside greater China. Two years earlier George Osborne, then Britain’s chancellor of the exchequer, had said that the Chinese currency would “become almost as familiar as the dollar” within his lifetime.
The International Monetary Fund would later add the renminbi to its reserve-currency club, the Special Drawing Right basket, describing it as a “milestone in the integration of the Chinese economy into the global financial system”.
But even before the IMF’s decision took effect in October, there were signs that SDR recognition might turn out to be the high water mark of the renminbi’s internationalisation rather than the dawn of a new, more diversified global monetary system.
Across a range of indicators, the extent of its global push has slowed and in many cases slipped into reverse.
The share of China’s foreign trade settled in its own currency has shrunk from 26 per cent to 16 per cent over the past year while renminbi deposits in Hong Kong — the currency’s largest offshore centre — are down 30 per cent from a 2014 peak of Rmb1tn. Foreign ownership of Chinese domestic financial assets peaked at Rmb4.6tn in May 2015; it now stands at just Rmb3.3tn. In terms of turnover on global foreign exchange markets, the renminbi is only the world’s eighth most-traded currency — squeezed between the Swiss franc and Swedish krona — barely changed from ninth position in 2013.
What appeared to be structural drivers supporting greater international use of the Chinese currency now appear more like opportunism and speculation. Between the renminbi’s de-pegging from the US dollar in July 2005 and its all-time high of 6.04 versus the dollar in January 2014, the renminbi gained 37 per cent as it followed a nearly uninterrupted path of appreciation.
An expectation that this would continue drew hundreds of billions of dollars in foreign capital into China, often exploiting loopholes in regulations designed to discourage speculative inflows, as investors hoped to profit from risk-free currency gains.
But the tide has turned. The renminbi hit an eight-year low versus the dollar late last month and is on track for its worst one-year fall on record. Investors are offloading renminbi assets and exploiting those same loopholes to move funds in the opposite direction.
“After years of living in a hugely prosperous economy and behind a relatively closed capital account, domestic households and corporates have a strong desire to diversify assets offshore,” says Wang Tao, chief China economist at UBS. “This has further swelled on the back of intensifying concerns about a domestic asset bubble.”
Trojan horse
An anticipated interest rate rise by the US Federal Reserve — that could come as early as Wednesday — and the election of Donald Trump have recently pushed the dollar to its strongest levelin 13 years. For China, that adds to the capital outflow pressure stemming from concerns over its slowing economy and spiralling debt. Interest rate cuts by the People’s Bank of China last year further reduced the appeal of renminbi assets for yield-hungry investors.
“There is a fundamental conflict between preserving stability and allowing the freedom and flexibility required of a global currency,” says Brad Setser, senior fellow at the Council on Foreign Relations and a former US Treasury official. “Now that the cost is becoming clear, Chinese policymakers may be realising they are not willing to do what it takes to maintain a global currency.
“Capital controls certainly set back the cause of renminbi internationalisation but they may well be the appropriate step for both China and the world, given the outflow pressure China faces.”
As a topic for banking conferences and think-tank seminars, renminbi internationalisation could not be beaten. It offered a way to expressdissatisfactionwith the US dollar-dominated monetary system, as laid bare by the 2008 financial crisis, while signalling an eagerness to do business with China’s large, fast-growing economy.