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IT is pretty obvious that change is afoot in the international monetary system. A couple of years ago， the yuan set off on a path of internationalization. Early on， we at Standard Bank had front-row tickets： in 2012， the Nigerian Central Bank announced from our offices in Beijing that they would convert 5 percent of their reserves into yuan. The trend has certainly captured the imagination.
Smartly， Beijing has been focusing on broadening the scope of the yuan’s usage， reaching beyond China’s geographical territory， widening the arc of currencies it is traded against， and increasing its use in denominating and settling cross-border trade and financial transactions. In other words， the agenda had been primarily about growing the yuan’s role as a medium of exchange.
Beijing recognizes that internationalization is not the same as being a reserve currency. Yes， its usage is a necessary condition for reserve currency status， but it certainly is not sufficient. To be clear， a reserve currency is one that is held as a store of value， which is an entirely different prospect. To this end， China has always needed to meet two preconditions - an open capital account and well-developed financial markets.
Significant reforms
To China’s credit， we have seen significant reforms to its economic model， such as floating the exchange rate， liberalizing interest rates， and opening up the capital account. At this time， on each of these scores， China still has some way to go， but it has to go slowly； fast-tracking this will expose the currency at a time when structural fragilities are manifest.
What is clear is that the path ahead of the yuan will be a slow grind spanning 20 years or so. We expect three broad stages. First， kicking off in 2009， the yuan shifted from a domestic means of payments and transactions to one used in the regional settlement of international trade. Next， the currency is expected to change from one used primarily for trade settlement to financial transactions and pricing of goods. Finally， central banks will be able （and willing） to purchase the yuan for reserves.
In November 2015， the intentions received a boost. The International Monetary Fund （IMF） completed its regular five-yearly review of the basket of currencies that makes up the Special Drawing Rights（SDR） and as expected， the yuan has been included， with the expansion to come into effect in October 2016. However， the inclusion in the IMF’s basket of reserve currencies does not mean the yuan will appreciate - especially if the People’s Bank of China（PBC） decides to permit market forces to play a larger role in shaping the currency’s trajectory. We will still see an upward bias to the U.S. dollar/yuan valuation over the coming months， trending toward 6.75 by mid-2016. Our view is that any positive reaction will prove to be temporary， due， in large part， to our U.S. dollar view and the continued policy divergence between China and the United States. The United States is preparing to start raising interest rates， while the European Central Bank will likely stand pat. These trends place China in a problematic position： on the one hand， its own economic fundamentals demand lower rates； on the other hand， the yuan is still man-aged with reference to the dollar.
Economic asymmetry suggests that Beijing cannot simultaneously avoid defaults and bankruptcies and maintain its exchange rate in the face of a tightening cycle out of the United States. In fact， it is our view that without additional depreciation， the balance of payments will not adjust as necessary， nor will the authorities assert themselves on domestic monetary conditions or end the deflation cycle.
It is noteworthy that China’s consumer price index increased from 1.3 percent year on year in October 2015 to 1.5 percent year on year in November of the same year. However， not only is that still a relatively subdued point， but the producer price index contracted by 5.9 percent for the second consecutive month， extending the decline to a staggering 45 months. After nearly four years of falling prices at the factory gate， China needs to find a way to end the deflation adjustment in order to generate economic momentum before the debt burden becomes too large a constraint on investment.
Stemming slowdown
Looking ahead， ongoing monetary support will contribute to intensifying currency weakness. After six interest rate cuts in the past 12 months， we expect interest rates to be reduced in the first quarter of 2016， making China one of the few central banks to be cutting rates at this time. The benchmark lending rate is likely to fall from 4.35 to around 3.60 in 2016.
Unfortunately， stressed corporate balance sheets are limiting the effectiveness of rate cuts. Stateowned companies and local governments have taken on too much debt over the past six years. Chinese bank assets have expanded four times faster than nominal GDP since 2009. Indeed， these cuts to interest rates are unlikely to stop the continuing slowdown in growth， but rather aim at stemming the pace of the economic slowdown. China’s economy ended 2015 with economic activity more or less stabilizing at the current levels. However， GDP growth is likely to slip from 6.9 percent in 2015 to 6.5 percent in 2016， and much like 2014， risks to the forecasts are tilted to the downside. So， the development of China’s foreign exchange market remains in an early stage， and there is a long way to go before the yuan is a truly international currency. Yet， despite the slow progress， we do expect that each year， more and more trade and investment will occur directly between the yuan and other currencies. And it seems obvious to Standard Bank that China will be more successful in globalizing the yuan and transacting in yuan in Africa than elsewhere. Why？ Well， yuan internationalization simply reinforces the convergence of commercial and diplomatic ties between China and Africa.
A few other key reasons stand out.
First， China’s leverage and influence on the continent has risen sharply because successes （small and large） have already been plentiful.
Second， China and Africa have a head-start on others as they have high-level political relations and the development of robust bilateral and multilateral institutions which will support the process， like the China Development Bank， the Export-Import Bank of China， and most recently the BRICS bank， the New Development Bank.
Third， commercial ties have just started. Chinese firms and people have arrived in Africa， risking resources. They have a long-term agenda and want to grow their businesses in Africa. They will need to open yuan accounts and use yuan products； workers will want to send money home.
Fourth， China buys and sells a lot to Africa， meaning there is fast-growing demand for and supply of the yuan.
Fifth， and more directly， internationalization will lower transaction costs， enable better working capital and improve risk management practices， which along with various incentives， will support trade flows. Similarly， investment will find support through cheaper sources of funding （raised in Hong Kong or through loans） and better protected capital （hedging instruments）， which will result in more favorable terms for African projects.
China-Africa transactions
Indeed， in his speech at the African Union Conference Center in May 2014， Chinese Premier Li Keqiang stated that China aims to see China-Africa trade increase from $220 billion to $400 billion， and China’s direct investment in Africa to increase to $100 billion. Li urged China and Africa to work together on financial cooperation projects. To this end， China pledged support for bilateral cooperation in cross-border local currency settlement， currency swap， and mutual establishment of financial branches.
Then at the Forum on China-Africa Cooperation Summit in Johannesburg in December 2015， President Xi Jinping announced that China will offer$60 billion of funding support. The package covers industrialization， agricultural modernization， infrastructure， financial services， green development， trade and investment facilitation， poverty reduction and public welfare， public health， people-to-people exchanges， and peace and security. It is without doubt that many of these initiatives are likely to further boost the use of the yuan in Africa. Ca
（The writer is a Beijing-based economist at the
Standard Bank Group）
Smartly， Beijing has been focusing on broadening the scope of the yuan’s usage， reaching beyond China’s geographical territory， widening the arc of currencies it is traded against， and increasing its use in denominating and settling cross-border trade and financial transactions. In other words， the agenda had been primarily about growing the yuan’s role as a medium of exchange.
Beijing recognizes that internationalization is not the same as being a reserve currency. Yes， its usage is a necessary condition for reserve currency status， but it certainly is not sufficient. To be clear， a reserve currency is one that is held as a store of value， which is an entirely different prospect. To this end， China has always needed to meet two preconditions - an open capital account and well-developed financial markets.
Significant reforms
To China’s credit， we have seen significant reforms to its economic model， such as floating the exchange rate， liberalizing interest rates， and opening up the capital account. At this time， on each of these scores， China still has some way to go， but it has to go slowly； fast-tracking this will expose the currency at a time when structural fragilities are manifest.
What is clear is that the path ahead of the yuan will be a slow grind spanning 20 years or so. We expect three broad stages. First， kicking off in 2009， the yuan shifted from a domestic means of payments and transactions to one used in the regional settlement of international trade. Next， the currency is expected to change from one used primarily for trade settlement to financial transactions and pricing of goods. Finally， central banks will be able （and willing） to purchase the yuan for reserves.
In November 2015， the intentions received a boost. The International Monetary Fund （IMF） completed its regular five-yearly review of the basket of currencies that makes up the Special Drawing Rights（SDR） and as expected， the yuan has been included， with the expansion to come into effect in October 2016. However， the inclusion in the IMF’s basket of reserve currencies does not mean the yuan will appreciate - especially if the People’s Bank of China（PBC） decides to permit market forces to play a larger role in shaping the currency’s trajectory. We will still see an upward bias to the U.S. dollar/yuan valuation over the coming months， trending toward 6.75 by mid-2016. Our view is that any positive reaction will prove to be temporary， due， in large part， to our U.S. dollar view and the continued policy divergence between China and the United States. The United States is preparing to start raising interest rates， while the European Central Bank will likely stand pat. These trends place China in a problematic position： on the one hand， its own economic fundamentals demand lower rates； on the other hand， the yuan is still man-aged with reference to the dollar.
Economic asymmetry suggests that Beijing cannot simultaneously avoid defaults and bankruptcies and maintain its exchange rate in the face of a tightening cycle out of the United States. In fact， it is our view that without additional depreciation， the balance of payments will not adjust as necessary， nor will the authorities assert themselves on domestic monetary conditions or end the deflation cycle.
It is noteworthy that China’s consumer price index increased from 1.3 percent year on year in October 2015 to 1.5 percent year on year in November of the same year. However， not only is that still a relatively subdued point， but the producer price index contracted by 5.9 percent for the second consecutive month， extending the decline to a staggering 45 months. After nearly four years of falling prices at the factory gate， China needs to find a way to end the deflation adjustment in order to generate economic momentum before the debt burden becomes too large a constraint on investment.
Stemming slowdown
Looking ahead， ongoing monetary support will contribute to intensifying currency weakness. After six interest rate cuts in the past 12 months， we expect interest rates to be reduced in the first quarter of 2016， making China one of the few central banks to be cutting rates at this time. The benchmark lending rate is likely to fall from 4.35 to around 3.60 in 2016.
Unfortunately， stressed corporate balance sheets are limiting the effectiveness of rate cuts. Stateowned companies and local governments have taken on too much debt over the past six years. Chinese bank assets have expanded four times faster than nominal GDP since 2009. Indeed， these cuts to interest rates are unlikely to stop the continuing slowdown in growth， but rather aim at stemming the pace of the economic slowdown. China’s economy ended 2015 with economic activity more or less stabilizing at the current levels. However， GDP growth is likely to slip from 6.9 percent in 2015 to 6.5 percent in 2016， and much like 2014， risks to the forecasts are tilted to the downside. So， the development of China’s foreign exchange market remains in an early stage， and there is a long way to go before the yuan is a truly international currency. Yet， despite the slow progress， we do expect that each year， more and more trade and investment will occur directly between the yuan and other currencies. And it seems obvious to Standard Bank that China will be more successful in globalizing the yuan and transacting in yuan in Africa than elsewhere. Why？ Well， yuan internationalization simply reinforces the convergence of commercial and diplomatic ties between China and Africa.
A few other key reasons stand out.
First， China’s leverage and influence on the continent has risen sharply because successes （small and large） have already been plentiful.
Second， China and Africa have a head-start on others as they have high-level political relations and the development of robust bilateral and multilateral institutions which will support the process， like the China Development Bank， the Export-Import Bank of China， and most recently the BRICS bank， the New Development Bank.
Third， commercial ties have just started. Chinese firms and people have arrived in Africa， risking resources. They have a long-term agenda and want to grow their businesses in Africa. They will need to open yuan accounts and use yuan products； workers will want to send money home.
Fourth， China buys and sells a lot to Africa， meaning there is fast-growing demand for and supply of the yuan.
Fifth， and more directly， internationalization will lower transaction costs， enable better working capital and improve risk management practices， which along with various incentives， will support trade flows. Similarly， investment will find support through cheaper sources of funding （raised in Hong Kong or through loans） and better protected capital （hedging instruments）， which will result in more favorable terms for African projects.
China-Africa transactions
Indeed， in his speech at the African Union Conference Center in May 2014， Chinese Premier Li Keqiang stated that China aims to see China-Africa trade increase from $220 billion to $400 billion， and China’s direct investment in Africa to increase to $100 billion. Li urged China and Africa to work together on financial cooperation projects. To this end， China pledged support for bilateral cooperation in cross-border local currency settlement， currency swap， and mutual establishment of financial branches.
Then at the Forum on China-Africa Cooperation Summit in Johannesburg in December 2015， President Xi Jinping announced that China will offer$60 billion of funding support. The package covers industrialization， agricultural modernization， infrastructure， financial services， green development， trade and investment facilitation， poverty reduction and public welfare， public health， people-to-people exchanges， and peace and security. It is without doubt that many of these initiatives are likely to further boost the use of the yuan in Africa. Ca
（The writer is a Beijing-based economist at the
Standard Bank Group）