Capital account opening will help increase use of the yuan among investors

One of the significant changes in the Government Work Report that Premier Li Keqiang delivered to the National People's Congress on March 5 was that "promoting the use of yuan globally", which had figured in the report of his predecessor Wen Jiabao, was not mentioned.

To be precise, it was the first time that the topic of the yuan's globalization was not touched upon in the annual government report since 2010. After the 2008-09 global financial crisis, China's policymakers decided to put yuan globalization at the top on their financial agenda, as they believed the dominance of the US dollar was the root cause of the crisis and that an internationalized yuan could help China reduce its exposure from a similar financial meltdown.

But it is premature to say the absence of the yuan globalization in the latest government report marks a policy turnabout.

Instead, the absence means the top leadership has realized that the Chinese currency faces hurdles in expanding further in world markets and is going to clear them.

There is no question that the yuan has gained popularity among global investors as a medium of three major financial activities - payments, trade and reserves.

According to the Society for Worldwide Interbank Financial Telecommunication, the yuan surpassed the Swiss franc to become the seventh most-used world payments currency in January.

The achievement came after the yuan vaulted ahead of the euro and Japanese yen to become the second most widely used currency in international-trade finance in October, behind the US dollar. Last year, cross-border trade settled in renminbi was worth 4.63 trillion yuan, a jump of 57 percent year-on-year, says the Chinese central bank.

There was other progress in the past couple of months, when the central bank of Nigeria said it would increase yuan holdings in its foreign exchange reserves from 2 percent to 7 percent, a sign of the currency's growing popularity as a global foreign-exchange reserve unit.

Despite these achievements, we must bear in mind that the yuan's popularity rests mostly on policy pushes and a wide rate difference that allows holders of the currency to make easy gains.

This can be seen by the fact that overseas investors and residents tend to hold yuan through receiving yuan from their Chinese buyers and allowing Chinese companies to invest in their markets using yuan. But they are reluctant to use yuan to buy Chinese goods or invest in China. This has resulted in a situation that the yuan's globalization is basically a one-way street.

The yuan has not gained the same popularity as the US dollar, which continues to be widely used by global investors, traders and governments even though it is depreciating and offers little room to speculate on its ultra-low interest rate.

What supports the greenback's global popularity includes the depth and liquidity of its domestic financial market, the currency's full convertibility and open market, but not its high interest rate or its potential to appreciate. Simply put, the US dollar beats the yuan with its convenience, backed by a sound and open financial system.

As the renminbi goes international, China's policy curbs on the currency and its rates become the biggest hinderance to its expanding further.

These curbs did not affect the yuan's globalization in the past mostly because the currency kept appreciating.

But as the yuan's appreciation is expected to slow sharply this year if it does not depreciate, overseas investors' desire to hold the yuan will be dampened, and the financial curbs the Chinese authorities place on it will further weaken their desire.

Fortunately, policymakers have noticed that. As seen in Premier Li's report, he deliberately did not mention the need to promote global use of the yuan, but stressed the need for financial reforms.

In the report, Li listed interest-rate liberalization, yuan trading band widening, and capital account opening as top priorities.

With interest rates fully liberalized, rate differences will be narrowed so that yuan holders will not always increase their yuan holdings for gains from the differences. Widening the yuan's trading band will allow market participants to have a bigger say in setting the foreign exchange rates, increasing their will to trade in the currency.

Capital account opening will allow investors to use yuan more easily and efficiently in and outside China. This will help promote the two-way flow of the yuan, increase the liquidity of the yuan market and boost the convenience to use the currency.

In this sense, the logic of Li is clear out there: Yuan globalization on high rates and appreciation can never be sustainable. It is time to increase its attractiveness by making it convenient and freer to use.

The authors are Shanghai-based analysts. The views do not necessarily reflect those of China Daily.

(China Daily European Weekly 03/14/2014 page10)