ENTER THE DRAGON - JSE MAGAZINE

ENTER THE DRAGON

China has great plans to challenge the dollar with its own currency the renminbi, especially in Africa. How far advanced are its ambitions?

ENTER THE DRAGON

In October 2013, the official Chinese news agency Xinhua announced that ‘it is perhaps a good time for the befuddled world to consider building a de-Americanised world’.

The occasion was the partisan stand-off between Democrats and Republicans that saw the federal government grinding to a standstill. It was 16 days before the impasse was resolved and the budget passed.

‘The cyclical stagnation in Washington for a viable bipartisan solution over a federal budget and an approval for raising debt ceiling has again left many nations’ tremendous dollar assets in jeopardy and the international community highly agonised,’ said Xinhua.

Anything that weakens the US dollar hurts China because the country owns the world’s biggest pile of dollars. China’s foreign reserves, mostly dollar-denominated, are worth some $3.2 trillion. The next largest reserves are those of Japan at $1.1 trillion followed by Russia at $516 billion. The dollar dropped 1.2% during the US budget crisis.

The real sting comes later in the Xinhua article. It suggests the introduction of a ‘new international reserve currency that is to be created to replace the dominant US dollar’. It is clear that China’s candidate is its own currency, the renminbi.

This is not a short-term goal and one of its important early steps is likely to be through Africa, where it is now the dominant trade power.

There have been several signs of Beijing’s influence on the continent. In 2011, Nigeria announced that it would convert 10% of its reserves into the Chinese currency.

The reserve banks of SA and Tanzania also hold renminbi with the currency comprising 13% of the South African Reserve Bank’s trade weighted exchange rate for the rand, making it the third most important currency in the basket. Also, SA and Nigeria have applied to tap into the offshore ‘dim sum’ bond market for Chinese-denominated debt.

Daouda Cissé, research fellow at the Centre for Chinese Studies at Stellenbosch University says it makes sense to use renminbi to finance China-Africa trade rather than incurring the arbitrage costs associated with a third currency like the US dollar.

There is sometimes confusion over the correct name of the Chinese currency. Its official name is renminbi while its units are referred to as yuan.

There are no serious pundits who believe the renminbi’s takeover will be rapid, or even inevitable. Martin Wolf of the Financial Times said: ‘China cannot offer a genuine alternative to the US dollar for at least a decade and possibly much longer.’

Wolf said he was ‘not worried [about the US dollar]. It might not look that [stable] but it’s the least terrible asset available. And people are risk averse at the moment. Right now the renminbi is not an alternative’.

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‘In practice the rise of the Chinese currency as a reserve asset is going to be very slow, slower than many people expect’

DAOUDA CISSÉ, RESEARCH FELLOW, CENTRE FOR CHINESE STUDIES

When considering the likelihood of China offering a future global reserve currency, it is useful to consider the function of such an instrument.

All countries hold financial reserves, in bonds or money market instruments denominated in another currency, as well as special drawing rights issued by the IMF. The purpose of these funds is two-fold – to facilitate trade and protect the currency against speculative outflows.

The best international reserve currency is one for which the market is both ‘liquid’ and ‘deep’. Since the Bretton Woods conference of 1944 this has meant the US dollar. US treasury securities are liquid, which means they can be sold quickly.

The market is also deep, which means substantial amounts can be bought and sold without affecting the price too much. An additional requirement for a good reserve currency is that assets denominated in that currency should be unlikely to lose value to any great extent.

Downgrades by rating agencies are considered to be one of the indicators of a currency in trouble. But markets don’t always follow the agencies.

In August 2011, the US received its first ever downgrade from Standard & Poor’s. But far from responding negatively, investors immediately bought both US dollars and treasury securities, causing both to rise by about 5%.

This event confirmed Wolf’s view that the US dollar is ‘the least terrible asset’ available. In 2011, the institutions that invested in US financials were doing so less out of positive sentiment towards the country than extreme negative perceptions of the euro, amidst the Greek fiscal crisis and similar problems in other EU countries.

From the point of view of internationalising renminbi, the problem for the Chinese government is to find ways of making the market for its currency deeper and more liquid. International investors simply don’t trust China yet. The US dollar and its lesser alternatives, the euro, yen and sterling have long histories and excellent track records of market responsiveness. Renminbi, by contrast, was pegged to the dollar until as recently as 2005 and the Chinese government still retains tight control of it.

It prohibited the export of the currency until 2009 and, although it is now allowed to ‘float’, the Chinese government heavily restricts the range within which it is allowed to trade.

Cissé argues that the main constraint is the non-convertible nature of the Chinese currency, and furthermore, that the Chinese bond market remains relatively illiquid. ‘With Beijing’s main focus on controlling capital flows and exchange rates, there are limitations to how much yuan can be reinvested in China’s financial market,’ he says.

It should not be thought that China’s drive to promote renminbi is simply the product of a nationalist agenda

Xiao Gang, chairperson of the China Securities Regulatory Commission, acknowledged these shortcomings in November 2013 when he spoke of the need to revise the countries regulations ‘to protect investor interest’.

Problems experienced by foreign companies in recovering debt in China are fast becoming the stuff of legend. The country is ranked at only 96 in the World Bank’s ease of doing business indicators, although Hong Kong is second in the world.

To further internationalise the renminbi, the Chinese government has to be patient and do what all globally dominant currencies throughout history have done – allow the money to follow trade. It is this factor that brings Africa so massively into play.

The growth of China’s trade with Africa has been one of the great stories. At the beginning of the millennium it was around $11 billion. In 2012, it was valued at $198.5 billion. By comparison America’s trade with Africa for the same year was $108.9 billion.

Projections put China’s African trade at $325 billion just two years from now.

Despite these dramatic figures, China has not suddenly taken over African trade, as occasional rabid warnings of ‘the new [Chinese] imperialism’ might suggest. According to the Carnegie Foundation, China accounted for 15% of Africa’s foreign trade in 2011.

Although the figure has increased since then, China hardly has a monopoly stranglehold over the continent. The country needs Africa at least as much as the reverse. Around 25% of China’s oil and mineral imports come from the continent.

Martyn Davies, CEO of Frontier Advisory, points to the multifaceted nature of China’s interest in Africa. The country is interested in expanding its markets (mostly for manufactured goods). It has strong resource security concerns especially in oil, coal and iron ore and is interested in Africa as a site for the extension of its geopolitical role, he says.

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At China’s main forum for announcing policy, the third plenum of the 18th Central Committee of the Communist Party, in November 2013, links with Africa were prominent on the agenda.

Davies argues that ‘Sino-African economic ties are at new highs this year’. He points out that President Xi Jinping chose the continent as one of his first destinations for a state visit when taking office.

Standard Bank’s Beijing-based economist Jeremy Stevens argues that Africa’s trade with China will increasingly be denominated in renminbi. He has stuck his neck out a little and predicted some 40% of the trade will be in renminbi by 2015.

Some of his colleagues are more cautious and suggest that 20% is a more likely figure. In 2012, according to global settlements services Swift, renminbi accounted for only 3% of the trade.

It should not be thought that China’s drive to promote renminbi is simply the product of a nationalist agenda.

Although there are, no doubt, those in the Beijing leadership who see the status of the currency as a matter of prestige, the considerations so far have been overwhelmingly practical.

Trade is a useful first step towards a more internationalised renminbi and the Chinese currency will increasingly be used to settle invoices as the country’s trade with Africa expands.

But as Cissé says: ‘In practice the rise of the Chinese currency as a reserve asset is going to be very slow, and maybe a lot slower than many people expect.’

China still has to persuade other countries to buy its bonds and that requires further reforms to the country’s financial system.

By David Christianson
Image: Andreas Eiselen/HSMimages