Time to strengthen financial economy

On March 26, 2018, China will launch yuan-denominated oil futures contract, convertible into gold on the Shanghai and Hong Kong stock exchanges, which could become another benchmark for crude oil. Usually, crude oil priced in Brent and West Texas Intermediate futures is denominated in US dollars. But it is still too early to say whether it will challenge the dollar's position and to what extent it would revise oil pricing model. However, the move is a good opportunity for China and the Gulf Cooperation Council member countries to strengthen their economic ties, and explore new areas for cooperation to extend their economic relations beyond energy exchange.

Basically, the need for such an oil futures contract emerged because of domestic developments, especially in the real economy. China and the GCC both are in the process of economic transformation. China emphasizes quality, slower but sustainable, and inclusive growth, and is on way to becoming a consumption-driven and service-led economy, while tackling short-term risks and long-term challenges.

The GCC requires to adapt to a "new oil normal", for which it has to reform the economic structure and shift its economic focus from oil. Apart from looking for non-oil growth drivers domestically, the GCC also has to seek more trade partners and diversify its financial assets and investment portfolios so as to build buffers against financial shocks. Such an economic structural adjustment has laid a foundation for both sides to establish a closer relationship. In particular, China's strong and stable economy provides the potential for deeper economic relations with the GCC.

The Arab Policy Paper of 2016 has provided guidelines for economic cooperation between China and Arab countries. The paper has set priorities for cooperation in a"1+2+3" framework, that is, the core area of energy, two areas of infrastructure construction, and trade and investment, and three breakthroughs in high and new technology/nuclear energy, space satellite, and new energy. The paper also emphasizes the Belt and Road Initiative, cooperation in production capacity, China-GCC free trade agreement negotiation, two-way investment facilitation and financial cooperation between monetary authorities and regulators.

The framework is extensive in terms of its coverage, and requires the engagement of multilevel players, such as governments, corporations, financial institutions and experts in various fields.

China is the GCC's primary trading partner, with their trade volume increasing from $39.3 billion a decade ago to $117.5 billion in 2016. Saudi Arabia and the United Arab Emirates are China's largest trading partners in the Middle East. Thirty percent of China's oil imports come from Saudi Arabia, Oman, Kuwait and the UAE.

Furthermore, the imports of high-skill and technology-intensive manufactured goods increased faster than low and medium-skill and technology-intensive manufactured goods, meaning the GCC countries have raised their position in the global value chain by trading with China.

Two-way investment and capital flow is beneficial for both sides. China is the largest investor in the Arab region with investments worth $29.5 billion in 2016, surpassing the United States in foreign direct investment. Project finance in the GCC countries has become increasingly attractive for Chinese investors thanks to the Belt and Road Initiative. Also, China is further reforming and opening up its domestic financial market, its bond market already ranks the third in the world and, although banking still dominates, direct financing is encouraged in order to improve the domestic financial structure.

The regulatory framework is unified to meet the needs for market development, and the regulatory approach has become more rule-based rather than being based on administrative orders. The quotas granted to Qualified Foreign Institutional Investors remain the major management tools for capital flow, with the UAE and Qatar being the two major investors.

And in November 2017, Beijing decided to open its financial sector, allowing foreign banks, securities firms, fund managers and life insurance companies to acquire ownership of companies in China. The importance of the move is that China wants to reaffirm its openness and continuity of policy in line with the new economic reform agenda set by the 19th National Congress of the Communist Party of China in October.

Currency cooperation is a new area for the two sides to explore. China's currency strategy provides additional opportunities for the GCC. One key area where the yuan can be used is energy trade, where traditionally the US dollar has dominated for decades. The launch of China's yuan-denominated crude oil futures contract is therefore a landmark move, which the GCC countries can use as an additional option.

As part of its yuan strategy, China is looking for establishing offshore yuan markets. By the end of last year, there were 23 offshore yuan markets worldwide, which would also help internationlize the Chinese currency. By hosting the branches of Industrial and Commercial Bank of China and Agricultural Bank of China, the Chinese banks designated as clearing banks, Doha and Dubai have become the two yuan centers in GCC countries. It's time therefore that the GCC realize its potential to play a bigger role as an established financial center.

Besides, the increasing acceptance of the yuan as an international currency makes it another option for reserve holdings. The yuan has been included in the International Monetary Fund's Strategic Drawing Right basket, and more than 60 central banks are holding it as reserve currency. The yuan is also being widely used as payment currency. And by using the yuan in transactions as their economic ties deepen, China and the GCC countries will minimize the exchange rate risks. The GCC may also consider including more currencies in its pegging basket, in order to allow the exchange rates to absorb the external shocks, for which the yuan is a logical candidate. Of course, cooperation among the central banks is essential for that to happen.

Overall, as China has increased its influence in the global economy, and its external economic and financial ties have expanded rapidly, it sees the GCC countries as strategic partners. So both sides should consider widening as well as deepening their economic and financial cooperation.

The author is a senior fellow at the Institute of World Economics and Politics, Chinese Academy of Social Sciences.