Yuan Internationalization Drive Hits A Local Speed Bump

In the past year, Fitch added,“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. We expect such issuance to continue in 2024.”

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 pushed back, asserting that“Fitch ratings don't effectively reflect prospectively the positive effects of fiscal policy on driving economic growth and thereby stabilizing macro leverage.”

Finance Minister Lan Fo'an's team argues that China's GDP is growing around 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, global investors and central banks aren't loading up on yuan assets the way Xi's government likely 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.

Overseas purchases of US government debt jumped 8.7% 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.

Dollar buying also confounds broader efforts by the BRICS economies to marginalize the globe's reserve currency.

The governments of Brazil, Russia, India, China and South Africa haven'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.

Hence the BRICS alliance's determination to dethrone the dollar by convincing developing countries to use local currencies for trade
and finance instead.

Efforts by US President Joe Biden's administration to damage China's tech industry and“weaponize” the dollar as part of policies to retaliate against Russia for its invasion of Ukraine have only intensified this determination.

Germany's Finance Minister Christian Lindner warns that the freezing of Russian assets amid Ukraine tensions could undermine international financial stability and sovereign immunity.

“If third parties have the impression that their sovereign assets are not safe under certain circumstances, international financial stability could be jeopardized,” Lindner says.“We would lose more than we would gain in the long run.”

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. The Federal Reserve was tipped to slash interest rates between five and seven times this year. Now, as inflation proves less transient than hoped, markets wonder if the Fed will ease at all.

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 about-face is contributing to the yen's plunge and keeping the yuan under downward pressure.

The yuan isn'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. Fears of further declines in the Philippine peso have led the central bank to delay rate cuts.

This month, as the International Monetary Fund and World Bank hosted their spring meeting, IMF Managing Director Kristalina Georgieva warned the dollar's strength has emerging economies struggling to stem big capital outflows.

“Higher interest rates for the rest of the world is not great news,” Georgieva explains.“Higher interest rates make the US more attractive so financial flows come here and that leaves the rest of the world somewhat struggling.”

Georgieva concludes that“if it continues for a long time, it could become a bit of a worry in terms of financial stability.”

In March, IMF data showed the US dollar accounted for almost 60% of all global foreign reserves. The currency's share of global foreign reserves actually rose 0.2 percentage points in 2023.

Yet Xi seems as determined as ever to increase the yuan's global stature.

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.

Joining the most exclusive currency basket along with the dollar, yen, euro and pound boosted trust in the yuan.

Sign up for one of our free newsletters

• The Daily ReportStart your day right with Asia Times' top stories
• AT Weekly ReportA weekly roundup of Asia Times' most-read stories

Its use in trade and finance has grown steadily since then. That increasing role earned Chinese government bonds a central place in bond benchmarks like FTSE-Russell's and in MSCI's stocks indexes and others.

Yet the yuan's softness risks reducing the appeal of Chinese assets. So do perceptions that
Xi's next five years may put his ambitions for greater control over increasing Chinese
competitiveness and transparency.

The odds are still good that the yuan's global role will grow exponentially as China modernizes its economy. Yet signs that China Inc is having doubts about the yuan's trajectory suggest Xi's de-dollarization drive is working better overseas – in terms of trade and official aid – than among Chinese companies.

One answer is for Xi and Li to step up reforms for the property sector, local government finances, capital markets development and recalibrating growth engines from exports to services and innovation. Beijing must also make the yuan fully convertible to increase global trust.

China's yuan still has a trust problem. Photo: Facebook Screengrab

The problem, says Alexandra Prokopenko, a senior fellow at the Carnegie Russia Eurasia Center, is that“it's believed that the yuan can't become a full-fledged reserve currency because of the current restrictions on capital transactions in China.”

Though growing yuan use by Russia and other sizable economies is“helping the Chinese authorities to make it into an international reserve currency,” Prokopenko notes, structural limitations mean it's“hardly a reliable substitution” for the dollar as yet.

Rodrigo Zeidan, a finance professor at New York University Shanghai, adds that“China cannot allow capital to flow entirely freely into its economy without risking another domestic currency crisis.”

He adds that“central to the yuan's future is whether China will attempt to de-dollarize the global economy or merely hedge against potential US sanctions. China is constrained to the latter for the next few years. Attempting to de-dollarize would require China to maintain free capital markets.”

Follow William Pesek on X at @WilliamPesek