China is preparing to make its currency Yuan a global currency.
Chinese President Xi Jinping has talked about establishing his currency Yuan as a global currency. The world is seeing this as a direct challenge to America. Jinping has expressed his intention in an article published in Qiushi, the main journal of the Communist Party. China has also taken steps in this direction.
China paid about a third of its foreign trade worth US$6.2 trillion last year through the yuan. Come, let us know on this pretext how the currency of any country can be made a global currency? What are the necessary steps for this?
What is global currency?
In fact, a global currency is a currency that is widely accepted and used around the world for payments in international trade, in the reserves of central banks, and in investment and financial markets. Currently the US dollar is the most prominent global currency. After that come the Euro, the Japanese Yen, the British Pound and partly the Chinese Yuan.
US dollar.
What are the conditions for making currency global?
Mere political slogans are not enough to make any country’s currency global. For this many deep and long-term steps have to be taken.
- Strong and stable economy: Continuously high and stable economic growth, low and controlled inflation, control on current account and fiscal deficit are some of its important conditions. Only when global investors are confident that a country’s economy will not collapse suddenly are they willing to hold reserves and trade in its currency.
- Strong and transparent financial system: For this, it is necessary that big brands show strength in the stock market. There should be stability in the banking sector, clear and reliable regulations. If a foreign investor cannot easily invest and withdraw money in the financial market of that country, then he does not adopt that currency as a reserve or global currency.
- Partial, complete independence of capital account: Foreign investors should have complete or sufficient freedom to enter and exit the country. Facility to convert currency easily. Capital controls cannot be too strict to become a global currency like the US dollar or euro.
- Political stability and institutional trust: Strong rule of law, protection of property rights, credibility of judiciary and regulatory institutions should be seen increasing day by day. Foreign central banks keep a currency in reserve only when they are confident that the government of that country will not suddenly arbitrarily freeze their assets or default.
- Geopolitical Influence and Security Network: Strong military and diplomatic power, financial and security umbrella to friendly countries are also necessary conditions for taking steps in this direction. The strength of the US dollar comes not only from the economy, but also from America’s defense system, alliances (NATO etc.) and global political influence.
- Deep presence in international organizations: It is important that a country that intends to create a global currency should play a big role in institutions like IMF, World Bank, BIS. International loans and aid are given mostly in the same currency, due to which even small countries start increasing their trade and reserves in the same currency.
China’s currency yuan.
Why does China want to make Yuan a global currency?
President Xi Jinping and the Chinese leadership have long been talking about reducing dependence on the dollar and internationalizing the yuan. Its main objectives include reducing the risk of US sanctions and dollar-dominance, increasing monetary and financial strength in line with China’s economic strength, making international transactions cheaper and easier for Chinese companies and banks, and increasing China’s soft power and diplomatic influence.
What steps is China taking?
China has been working for a long time towards making Yuan an international reserve currency. In 2016, the IMF included the yuan in its Special Drawing Rights (SDR) basket. China is continuously encouraging foreign central banks to keep reserves in yuan. Central banks of many countries are making limited but increasing investments in Chinese bonds and yuan assets.
China has intensified efforts towards oil and commodity trade (Petro-Yuan) in yuan, especially with Russia, Iran and some Gulf countries. Many loans and project funding under the Belt and Road Initiative (BRI) are being given in yuan. China is making local currency settlement agreements with some countries in Asia, Africa and Latin America, so that payments can be made directly in yuan-local currency instead of dollars.
1- CIPS and Alternative Payment System
China created the Cross-Border Interbank Payment System (CIPS), an effort to reduce reliance on SWIFT and facilitate yuan-based international transactions. The importance of CIPS increased further after Western sanctions on countries like Russia, because some countries are looking for yuan payment channels instead of dollars.
Chinese President Xi Jinping
2- Digital Yuan (e-CNY)
China has taken the lead in the world and started large-scale testing and partial use of Central Bank Digital Currency (CBDC) i.e. Digital Yuan. In the long term, China may move towards using the digital yuan in cross-border payments and BRI projects. The digital yuan makes transactions faster, cheaper and traceable, allowing China to gain a technological edge over the payment system.
3- Steps towards opening financial markets
China started programs like Bond Connect, Stock Connect, through which foreign investors are able to access the bond and stock markets of Mainland China through Hong Kong. Gradually, the market size of Yuan denominated bonds (Dim Sum Bonds) and Panda Bonds has increased, making yuan assets attractive for international investors.
What more efforts will China have to make now?
The yuan is still lagging far behind the dollar and euro globally. To move forward in this direction, China will have to work on some challenges. China still maintains strict capital controls so that capital flight does not occur on a large scale. To become a global currency, investors must be confident that they can withdraw money from China at any time. But if China suddenly lifts capital controls, the risk to domestic financial stability may increase.
Globalization of any country’s currency is not only an economic but also a political, institutional and geopolitical process.
Striking this balance is one of China’s most difficult challenges. Foreign investors do not have the same confidence in Chinese courts, regulators and the rule of law as they do in America or Europe. The role of the party-state is very strong, and there remains the possibility of sudden policy change or intervention. If the yuan is to become truly global, China will have to move toward a more transparent, predictable, and autonomous institutional structure.
Depth and transparency in the domestic financial sector
The Chinese banking system faces risks such as non-performing loans (NPAs), real estate sector and local government debt. Global investors will buy yuan assets on a large scale only when they have confidence in the correct picture and data on these risks.
Geopolitical mistrust and tensions
Due to US-China rivalry, Taiwan issue, South China Sea dispute and trade and technology war, there is deep suspicion towards China in western countries. Many countries are economically dependent on China, but are security and strategically linked with America. They are cautious in abandoning the dollar and openly adopting the yuan. China will have to create an environment of comprehensive trust through its foreign policy, diplomacy and security partnerships.
The Dollar Network has very deep roots
Most of the world’s commodity contracts, global debt instruments, SWIFT payment channels and Forex reserves are still based on the dollar. De-dollarizing this established network will be a slow and lengthy process. China will have to make sustained efforts over decades to gradually increase the share of the yuan; it does not seem possible to suddenly replace the dollar.
In this way, we can understand that making any country’s currency global is not only an economic but also a political, institutional and geopolitical process. Becoming a global currency requires a strong economy, stable financial system, capital account freedom, legal confidence and broad international cooperation. China has taken many concrete steps for the internationalization of the yuan. Yet for the yuan to become a dominant global currency, China will have to work harder on loosening capital controls, increasing institutional transparency, reducing financial risks, and reducing geopolitical mistrust. It is clear from Xi Jinping’s latest initiatives that China is committed to the long haul, but challenging dollar dominance is a decades-long project, which will be both gradual and complex.
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