The Chinese yuan may become the third-largest global currency, after the dollar and the euro, by 2030, according to analysts at Morgan Stanley. The yuan share in world reserves is below 2%, but, according to Morgan Stanley, that share will grow to 5% in the worst case scenario, and up to 10% in the best case scenario.
Analysts referring to an upward trend in global investor demand for Chinese securities noted that, in July, foreign capital net inflows into Chinese bonds reached $21.3 billion, the highest since 2014, when the statistic was first published. The total value of foreign investor bonds reached $360 billion, which is 13.7% more than last year.
This trend will greatly strengthen the yuan’s role in the international arena in the future, according to a Morgan Stanley report. The financial multinational corporation claimed that this decade, portfolio investments will become China’s main channel for capital inflow, while direct investment will drop into the background.
Analysts say that this year the total volume of attracted portfolio investments in China will amount to $150 billion, and will increase to $200-300 billion, from 2021 to 2030. Considering that Beijing, as well as investors, are interested in attracting capital and claiming an increase in the openness of their financial markets, an increasing share of global assets could be denominated by the yuan in the future.
The yuan was included in the SDR basket in 2016; since then central banks in some countries have set up reserves in the Chinese currency. As of the end of 2019, 70 central banks had at least some yuan included in their reserves, while in 2018 there were only 60. However, the yuan’s total share in global foreign exchange reserves do not exceed 2%.
According to IMF statistics, in the first quarter of 2020, the dollar share in world reserves stood at 61.9%, the euro share at 20.05%, the yen share at 5.70%, and the pound share at 4.43%. According to Liu Dongmin, head of the Centre for International Finance at the Institute of World Economics and Politics, at the Chinese Academy of Social Sciences, there are several factors hindering the yuan’s acceptance internationally.
“Currently, the most important factor determining the yuan’s internationalisation is the level of openness of the current account. China hasn’t fully opened it so far. Of course, this severely limits the yuan’s internationalisation. There are other factors as well, including the yuan’s free convertibility”.
“The current account’s liberalisation depends on it as well. If the yuan cannot float freely, it’s very difficult to achieve full liberalisation of the current account. Moreover, an important role is played by the level of openness of the Chinese financial markets. If they are fully open, it helps to attract more foreign investment. Finally, it is also important that the Chinese economy maintains high growth rates over the medium and long term”.
Morgan Stanley analysts believe that Beijing’s current account will become a deficit in the near future. As China seeks to change the growth model of its economy, switching from export to domestic consumption, it will inevitably absorb more than it produces; absorption here stands for consumption, investment and government spending.
China’s current account deficit is projected to be minus 1.2% of its GDP by 2030. In this context, according to Morgan Stanley, to finance this deficit from 2025 to 2030, China needs a foreign capital net inflow of at least $180 billion per year.
Liu Dongmin pointed out that the focus on gradually opening the current account and financial markets remains unchanged and agreed that Morgan Stanley’s forecasts regarding the yuan’s increasing role in international financial system are justified.
“I think that the forecast is quite justified because the Chinese economy is currently showing good results. The fight against the pandemic has been successful, which makes Chinese markets attractive to investors. Many Western investors have shown more interest in Chinese capital markets”.
“We see that the yield on Chinese securities is higher than on similar securities in Western markets. Therefore, foreign investors investing yuans in Chinese markets get higher returns than those investing in the Western markets. This is the key factor in attracting foreign investors. Moreover, China is actively reforming its financial sector and opening up financial markets. So I think the Chinese market will become even more attractive for foreign investors in the future. Finally, the Chinese economy is showing stable growth. All this creates conditions for attracting foreign capital”.
To counter the current crisis, most countries with developed financial markets have launched minimum or even zero-interest rate policies, making global investment less profitable. China has abstained from the practice, maintaining interest rates at a higher level, and generally pursuing what is considered by some to be a moderate monetary policy.
The spread between the yields on Chinese and other markets makes the China market more attractive to investors, if investment reliability in Chinese and, for example, American securities, is comparable.
Despite a complicated international political situation, Beijing is said to be taking steps to facilitate foreign capital access to the Chinese market. Just a few days ago, financial regulators published new draft rules for foreign investor access to the Chinese bond market. The new rules simplify a number of formal procedures and standardise opportunities for foreign investors to access different types of securities markets in the country.
The stop list for foreign investment is constantly being reduced, according to reports, and a number of restrictions on foreign capital shares for banking, insurance and brokerage have been lifted this year. Many foreign financial corporations have applied for full control of their own joint ventures in China, as a means of side-stepping state control oversight by Beijing.
JP Morgan recently became the first corporation to receive full control over its business in China. Other major global players, including UBS Group AG, Nomura Holdings Inc. and Credit Suisse, have followed suit.