The Chinese Yuan (RMB) as a Hard Currency

At least for now, the RMB becoming a truly international or hard currency will be put on hold.

Investopedia defines hard currency as being “widely accepted around the world as a form of payment for goods and services,” and as a currency expected to remain relatively stable in the short run.[1] It must also be highly liquid in foreign exchange markets. The U.S. dollar (USD) is one of the best examples of a hard currency. According to Investopedia, it is the both the most traded currency and the world’s choice of reserve currency. Seventy percent of the world’s international trade is conducted using the US dollar.

Currently the world has seven other hard currencies the next most traded currencies are (in descending order): the European euro (EUR), Japanese yen (JPY), British pound (GBP), Swiss franc (CHF), Canadian dollar (CAD), Australian/New Zealand dollar (AUD/NZD) and South African rand (ZAR).[2] Conspicuously absent from the list is the Chinese RMB (Chinese Yuan). Although the RMB is counted among only five currencies to be included in the prestigious Special Drawing Rights (SDR) currencies of the IMF, the RMB still does not qualify as a hard currency.

Other attributes of a hard currency are that it is issued by a politically stable government and by a country with a large GDP. China is certainly politically stable and its GDP is second in the world. The RMB however fails to meet other metrics of usability and acceptance as a reserve currency by central banks.

Demonstrating how limited the use of the RMB is outside of China, Gwynn Guilford reported in Quartz that in 2015,although the RMB was the fifth most used currency globally, it only accounted for 2.5% of all international payments tracked by SWIFT, as opposed to 43.3% for the dollar or 28.7% for the euro. She also reported that 70% of the international transactions involving the RMB were between Hong Kong and the mainland. If Hong Kong is excluded, then the RMB only accounts for 0.8% of global SWIFT payments.[3]

The US dollar accounts for 61% of total foreign currency reserves, while the euro is in second place accounting for 25%.[4] One of the many reasons why central banks are not holding significant quantities of RMB in their currency reserves is that “Central bankers also tend to maintain currency reserves in proportion to their actual use”.[5] As the RMB only accounts for about 2.5% of global transactions, the percentage of RMB kept by most central banks is quite low.

The one continent where China is making headway in terms of RMB use is Africa.[6] Zimbabwe a country deep in the grips of a currency crisis stemming from hyper-inflation. According to the Cato Journal, in November 2008 inflation reached a whopping 79.6 billion percent. Zimbabwe has now added the RMB to a basket of currencies now used in the country[7]. The addition of the RMB, which is tied to a loan agreement, does not seem to have changed the fact that the country is still using the US dollar as its primary currency.[8] Other African nations, who also borrow from China, have agreed to keep small percentages of their reserves in RMB. In 2014, the Central Bank of Nigeria agreed to keep 2% to 7% of its foreign reserves in RMB.[9]

The Chinese economy and currency in Quarter 1, 2017

According to Lang (2017), China’s capital outflows in 2016 totaled between $650 billion and $1 trillion.[10] At the same time, China’s debt level has continued to rise, as ambitious economic growth targets have been fueled by borrowing. Lang (2017) reports that this growth model has led to “an unstable market environment with manufacturing overcapacity.”[11] According to The Guardian, China’s use of debt reached record proportions.[12] After a 2016 review, the IMF issued a warning regarding China’s increasing debt, which they calculated to be 237% of GDP. Out of that 237%, corporate debt accounts for 145%.[13] The borrowing shows no sign of stopping. According to MSN, China has set a 2017 growth rate of 6.5%, which will necessitate incurring more debt and possibly further liquidations of foreign capital reserves.[14] While a growth rate of 6.5% seems ambitious, it still represents a decrease from the previous year’s projections. Other signs of a slowing economy include the government’s announcement that it will reduce fixed asset investment to 3% to 4% in 2017, as opposed to 7% the previous year. [15]

While debt levels rise in China, the currency continues to drop. According to Reuters, during 2016, the RMB dropped 6.6% against the dollar. Additionally, the country’s legendary foreign currency reserves dropped below $3 trillion for the first time in six years. The weak yuan will make it more expensive for Chinese companies to service loans in dollars.[16] According to Wok Richter at Wolf Street, Chinese companies now owe over $1 trillion in dollar denominated loans.[17]

As China’s economy is so dependent on trade, particularly with its largest customer, the United States, friction with the new US administration could prove problematic for the Chinese economy. With the potential of lost US markets and a depreciating currency, tighter credit, high debt, low investor confidence, and decreased investment, Gordon Or of McKinsey says it is unlikely that China’s 2017 growth rate will be able to match its 2016 growth.[18] The OECD predicted that Chinese GDP growth could drop to 6.1% by 2018.[19]

What this all means for the currency is that it seems very unlikely that the RMB will become the reserve currency of choice any time soon. Kimberly Long of Euro Money reports that in the final quarter of 2016, the RMB slipped from fifth to sixth place for SWIFT payments.[20] At least for now, the RMB becoming a truly international or hard currency will be put on hold. As the IMF has noted, “the currency’s progress [has] stalled, as China grappled with a growth slowdown, a sharp boom and bust cycle in the stock market, and concern about rising debt and financial instability”.[21]