As Taiwanese leader Xi Jinping works to increase the yuan’s role in global business and finance, he’s encountering an unforeseen rate knock: island companies.
Corporate executives are putting their feet down when it comes to converting foreign exchange earnings into local currency, according to new data from the People’s Bank of China ( PBOC).
In March, FX deposits rose to US$ 833 billion from$ 779 billion a month earlier, signaling that businesses are slow-walking moves to swap earnings into their home currency.
The most obvious explanation: higher offshore interest rates that are contributing to a weaker-than-expected yuan.
This enormously positive yield spread is not going to vanish anytime soon, according to Alvin Tan, a currency strategist at RBC Capital Markets.
The US and China rate differential is the most significant since 2007. This important fundamental fact, according to Tan, suffices to explain why Chinese exporters are reluctant to exchange dollars for yuan. ”
Another reason for Beijing’s currency managers to resist the urge to chase a falling yen downward in the months to come. It might have negative effects because it contradicts Xi’s grand plan for “yuanization.” ”
Granted, Xi and Premier Li Qiang have so far resisted the urge to devalue. A weaker exchange rate may be just the thing to boost exports and keep the country’s largest economy from experiencing deflationary strains, but it could also be the thing to keep exports at 5 % and keep deflationary pressures at bay.
There are a variety of reasons why Pan Gongsheng, the governor of the PBOC, and Team Xi have not followed the yen lower.
For one thing, it would make it more difficult for property development companies to pay offshore bonds, increasing the likelihood of more defaults involving China Evergrande Group. For another, it could make China an even bigger flashpoint ahead of the November 5 US election.
The biggest worry, though, is damaging Xi’s long-term priority to internationalize China ’s currency as an alternative to the US dollar.
According to Dmitry Dolgin, economist at ING Bank, “it appears that China’s expanding trade ties and financial infrastructure suggest that the potential for further yuanization has not been exhausted.”
As the yen drops to 34-year lows, Yoet Xi’s balancing act becomes more challenging. The yen ’s 9. 7 % drop this year alone is n’t making Beijing’s life easier as it struggles to stabilize consumer prices.
A stronger GDP may also give Xi’s reform team more latitude to deal with China’s property crisis, lessen the rate of rising youth unemployment, and lessen runaway local government borrowing.
When Fitch Ratings downgraded China ’s sovereign credit rating to “negative” from “stable ” earlier this month, it listed local and regional governments ’ financial strains among its biggest worries.
Municipalities, Fitch said, “have been affected by the property slowdown and some local government financing vehicles ( LGFVs ) are facing refinancing pressures. ”
According to Fitch, in the past year,” some highly indebted regions were permitted to issue about CNY1.” 4 trillion ($ 193. 5 billion ) in refinancing bonds to bring LGFV debt directly onto their balance sheets. In 2024, we anticipate that this issuance will continue. ”
So far, banks have been requested to support LGFV debt structures through restructurings, while local asset management companies have also stepped in with support, Fitch notes.
China’s Ministry of Finance responded by claiming that Fitch ratings do n’t effectively account for the potential benefits of fiscal policy in terms of fostering economic growth and stabilizing macro leverage. ”
The team led by Finance Minister Lan Fo’an asserts that China’s GDP is increasing by about 5 %. 3 %, contributing more than 30 % to world output.
As such, Beijing claims, “the long-term positive trend of China ’s economy has not changed, nor has the Chinese government’s ability and determination to maintain good sovereign credit. ”
Even so, central banks and international investors are n’t buying yuan assets as much as Xi’s government had hoped.
One reason is the US dollar’s stubborn strength. In February, foreign holdings of US Treasury securities surged to a record — and a fifth straight monthly rise — despite Washington ’s national debt hitting$ 35 trillion.
US government debt purchases increased by 8 % on average. 7 % in February alone to$ 7. 965 trillion, up from$ 7. 945 trillion in January as Belgium, Japan, the UK and other top economies loaded up on dollars.
This dollar-hoarding is more than offsetting Beijing’s efforts to reduce US holdings. In February, China ’s stockpile of Treasuries dropped$ 22. 7 billion to$ 775 billion.
The BRICS economies ‘ wider efforts to marginalize the world’s reserve currency are also spooked by dollar purchases.
The governments of Brazil, Russia, India, China and South Africa have n’t been quiet about “de-dollarization ” efforts, with an important assist from Saudi Arabia and other OPEC members.
Given China ’s scale and role as the top trading nation, a pivot from dollars to yuan seems like the most obvious changing-of-the-guard option.
Defined by the BRICS alliance’s desire to dethrone the dollar by persuading developing nations to use local currencies for trade and finance instead.
This determination has only grown more powerful as a result of US President Joe Biden’s administration’s efforts to undermine China’s tech sector and “weaponize” the dollar as part of policies to punish Russia for its invasion of Ukraine.
Christian Lindner, the minister of finance in Germany, warns that the thawing of Russian assets in the wake of Ukraine’s tensions could threaten sovereign immunity and financial stability.
International financial stability may be endangered, according to Lindner. We would lose more in the long run than we would gain. ”
Yet the ditch-the-dollar enterprise seems to have lost momentum, at least for now, as the dollar continues to advance. This month, the DXY index, a key measure of dollar strength, is up nearly 5 % so far this year.
One reason the dollar is confounding the BRICS is the durability of the “higher-for-longer ” era for US yields. Interest rates were expected to be cut by the Federal Reserve between five and seven times this year. Markets now wonder if the Fed will ease at all as inflation proves to be less transient than expected.
Lawrence Summers, the former US Treasury secretary, even wonders if the next move by Chairman Jerome Powell’s Fed might be to hike rates instead. This reversal is causing the yen to fall and keep the yen in decline.
The yuan is n’t alone. India’s rupee recently dropped to an all-time low versus the US dollar. Malaysia’s ringgit is trading near its lowest levels since the 1997-98 Asian financial crisis. The central bank has delayed rate cuts due to concerns about further declines in the Philippine peso.
IMF Managing Director Kristalina Georgieva warned this month that emerging economies are struggling to stem large capital outflows as the International Monetary Fund and World Bank hosted their spring meeting.
The rest of the world’s interest rates are not encouraging, Georgieva asserts. Higher interest rates increase the US’s appeal, making financial flows flow here, which causes the rest of the world to struggle a little bit. ”
Georgieva comes to the conclusion that, if it persists for a long time, it might turn out to be a little uneasy in terms of financial stability. ”
In March, IMF data showed the US dollar accounted for almost 60 % of all global foreign reserves. The share of global foreign reserves in the currency increased by 0 percent. 2 percentage points in 2023.
Despite this, Xi seems as determined as ever to raise the yuan’s reputation worldwide.
In 2016, Xi’s efforts to strengthen the financial system and increase transparency paid off when the yuan was welcomed into the International Monetary Fund ’s “special-drawing rights ” program.
The yuan’s trust increased as a result of joining the most exclusive currency basket with the dollar, yen, euro, and pound.
Since then, its use in finance and trade has increased steadily. In FTSE-Russell’s and MSCI’s stocks indexes and others, Chinese government bonds held a prominent position in that growing role.
However, Chinese assets may lose value because of the yuan’s softness. So do perceptions that In Xi’s next five years, his goals for greater control may outweigh growing Chinese influence. competitiveness and transparency.
The yuan’s potential impact on the world as China modernizes its economy is still a good one. In terms of trade and official aid, there are indications that China Inc. is having doubts about the yuan’s trajectory, which suggests that Xi’s de-dollarization strategy is working better abroad than among Chinese businesses.
One solution is for Xi and Li to intensify reforms in the sectors of the property sector, local government finances, capital markets, and shifting the focus from exports to services and innovation. To increase global trust, Beijing also needs to fully convert the yuan.
According to Alexandra Prokopenko, a senior fellow at the Carnegie Russia Eurasia Center, the issue is that “it is believed that the yuan ca n’t become a full-fledged reserve currency because of the current restrictions on capital transactions in China. ” ”
Although Russia and other sizable economies are using the Yuan to boost its status as an international reserve currency, Prokopenko notes that due to structural constraints, it is still a difficult currency to substitute for the dollar.
According to Rodrigo Zeidan, a professor of finance at New York University Shanghai, China cannot permit the flow of capital freely into its economy without running into a second domestic currency crisis. ”
According to him, it is important to see whether China will try to de-dollarize the world economy or to merely hedge against potential US sanctions. China’s access to the latter will remain limited for the foreseeable future. China would have to maintain free capital markets in an effort to de-dollarize. ”
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