US interest rate concerns drive renminbi's ascendancy

Over recent months, a seemingly surprising trend has emerged on the global financial landscape — foreign investors are flocking to Chinese renminbi bonds, even as US bonds boast higher yields.

As of July, overseas institutions' holdings in China's interbank bond market had risen for 11 consecutive months, an increase in foreign holdings of as much as 1.28 trillion yuan ($179.78 billion), according to data from the Shanghai head office of the People's Bank of China, the country's central bank.

At first glance, the inflow looks counterintuitive — why would investors opt for lower-yielding bonds? As of late August, the 10-year US Treasury bonds still yielded around 1.67 percentage points more than their Chinese counterparts, according to market tracker Wind Info.

The answer, analysts suggest, partially lies in the anticipated interest rate cuts by the United States.

The US Federal Reserve is expected to lower rates from the current 5.25 to 5.5 percent range, to avoid a recession. With China's monetary policy to remain stable, the renminbi is poised to rebound against the dollar. This has set the stage for profitable exchange rate plays, with the possibilities of investors converting dollars to renminbi, investing in Chinese bonds, and locking in a profit by selling renminbi forward at a higher rate.

From October 2023 to January 2024, Chinese bonds yielded 107 basis points higher on average than US bond yields of the same maturity after taking into account foreign exchange hedging, according to calculations by BOC International.

Resilience of assets

A more fundamental reason for the inflow, financial experts from home and abroad said, is something beyond technical trading strategies — the growing appeal of renminbi-denominated assets among international investors, a trend that has withstood the headwinds of US rate hikes.

Since the US Fed started a drastic rate hike cycle in March 2022 to combat inflation, foreign holdings in China's interbank bond market have risen. They reached 470 billion yuan as of July, with the 1.28-trillion-yuan inflow since September last year surpassing the outflow of 810 billion yuan between March 2022 and August 2023, according to the PBOC's Shanghai head office.

The allure of renminbi-denominated assets has been underpinned by a global shift away from over-reliance on the US dollar, China's expansive economic ties, and the country's ongoing financial opening-up, the experts said.

These factors, they said, will continue to help the renminbi's ascent as an international currency, strengthening its reserve, payment, financing and pricing functions, and offering a win-win for the global economy.

"Demand for diversification of reserves away from the US dollar remains strong globally, driven by geopolitical, economic and financial dynamics," said Massimiliano Castelli, head of strategy for official institutions at UBS Asset Management.

"We believe the dollar is and will remain for the foreseeable future the main store of value for global investors, including reserve managers. However, currency diversification is set to continue in the future as the world gradually moves toward a multipolar system.

"The renminbi looks set to continue its steady rise in global foreign exchange reserves, in particular if it is supported by an improvement in the Chinese economy, the ongoing rise in the use of the renminbi in cross-border payments and the more widespread use of the digital yuan," said Castelli.

Zhu Min, former deputy managing director of the International Monetary Fund, said, "The world sees that a dominant US dollar is not necessarily a good thing for the whole world, because US monetary policy and fiscal policy may have a big impact on the dollar's value and capital movements."

"Having a more balanced force against the dollar is good for the whole world. So I think the renminbi will continue to internationalize to serve that role, not only for China, but for the whole world, and particularly for international financial architecture," Zhu said.

The world's pursuit of alternative international currencies to the greenback, including the renminbi, has accelerated after the US froze the Russian central bank's foreign exchange reserves and removed several Russian financial institutions from the Swift messaging system in 2022, in the wake of the Russia-Ukraine conflict.

'Shaky' greenback

Zhang Ming, deputy director of the Institute of Finance and Banking, which is part of the Chinese Academy of Social Sciences, said the "weaponization" of the dollar has presented an important opportunity for renminbi internationalization.

Many countries have realized that it is dangerous to rely solely on the greenback, said Zhang, who is also deputy director of the National Institution for Finance and Development.

In July, the renminbi's share in global payments, measured by value, hit a record 4.74 percent, Swift data showed. It remained the fourth most active currency for global payments by value for the ninth consecutive month.

The Chinese currency was the second-largest global currency in the trade finance market for the second consecutive month, with a market share of 6 percent in July.

As the world has sought systems other than Swift, the Cross-border Interbank Payment System, or CIPS, which specializes in renminbi cross-border payment and clearing, has grown in popularity. In July, two direct and six indirect participants were added to CIPS. By the end of July, there were 150 direct participants and 1,401 indirect participants in the system.

An increasing number of economies are also experimenting with central bank digital currencies, or CBDCs, in cross-border payments, which can not only bypass the Swift system, but enjoy a faster settlement speed than the traditional agent bank system, as a third party intermediary is no longer required.

Earlier this year, Saudi Arabia joined Project mBridge, a cross-border platform for experimenting with CBDCs — including the digital yuan — for international trade, as the sixth full participant.

Project mBridge resulted from collaboration starting in 2021 between the Bank for International Settlements' innovation arm, the Bank of Thailand, the Central Bank of the United Arab Emirates, the Digital Currency Institute of the PBOC, and the Hong Kong Monetary Authority.

Global, domestic challenges

Geopolitical dynamics, however, can be a double-edged sword, experts said, with The Wall Street Journal reporting in April that the US was drafting sanctions that threaten to cut some Chinese banks off from the global financial system.

A survey by UBS Asset Management of 40 central banks, which manage about half of the global foreign exchange reserves, showed that 47 percent of them believed that US-China tensions had not yet affected the internationalization trend of the renminbi. Thirty-nine percent said it had slowed it down and 14 percent said the tensions had accelerated the trend.

Zhang, from CASS, identified the US' suppression of China as a key challenge facing the renminbi's internationalization. This is in addition to domestic challenges such as economic growth slowing, the yields of financial products declining, and domestic financial risks becoming more apparent.

While ramping up efforts to boost economic growth, China can further internationalize the renminbi through three main tasks, Zhang said. They are: improving the currency's function in commodity pricing, providing more high-quality renminbi financial assets to overseas investors via both onshore and offshore markets, and stepping up the development of CIPS.

He said: "Since the PBOC began promoting renminbi internationalization in 2009, it has made significant progress over the past 15 years — the renminbi now holds about a 5 percent share in international transactions and 2 to 3 percent in global reserves. The area that remains relatively weak is pricing."

To further strengthen the renminbi's pricing function, China — as a major buyer and seller of commodities — can promote renminbi pricing in the trade of commodities such as iron ore, copper and natural gas, Zhang said. He cited the example of Shanghai's launch of an international crude oil futures market denominated in renminbi in 2018, which has grown rapidly into the third largest of its kind in the world.

The resolution adopted at the third plenary session of the 20th Central Committee of the Communist Party of China in July said that efforts should be made to steadily and prudently advance the internationalization of the renminbi and develop offshore renminbi markets.

It also said the country would push forward the development of a homegrown, controllable cross-border payment system and make steady progress in the R&D and application of the digital renminbi.

Zhang said CIPS would serve as a "backup option" for China and the world, particularly if geopolitical conflicts continue to escalate and the US imposes further financial sanctions. "Not only China, but also the European Union, India and Saudi Arabia are looking for new payment and settlement systems. We are providing these countries with a second or third option as well," he said.

Attracting participants

Efforts are needed to boost the number of banks directly participating in CIPS. The more direct participants there are, the stronger the network will become and the faster payment and settlement will be, Zhang said.

Project mBridge may assume greater importance going forward as an alternative and more efficient option for global payment and settlement, he added.

Xiong Aizong, a senior research fellow at CASS' Institute of World Economics and Politics, said there is room for development concerning offshore renminbi clearing, which can increase the cross-border trade and use of the yuan.

"Last year, renminbi clearing banks or arrangements were established in Brazil, Pakistan, Serbia, Cambodia and other economies, which greatly promoted the use of renminbi by enterprises and financial institutions in these economies for cross-border transactions," Xiong said.

Deepening high-level financial opening-up to expand the channels for foreign investment in renminbi assets is also key to internationalizing the currency, he said. The Bond Connect program launched in 2017, the improved qualified foreign institutional investor mechanisms, and the Swap Connect market access scheme launched last year, have all added to the currency's appeal to international investors, Xiong added.

Pan Gongsheng, governor of the PBOC, said in an interview with People's Daily in August that the central bank will promote renminbi internationalization by adhering to market-driven and voluntary principles, continue to improve cross-border renminbi policies, optimize the global layout of renminbi clearing banks, and promote the healthy development of the offshore renminbi markets.

In line with Pan's remarks, the PBOC in August inked a memorandum of understanding with Vietnam's central bank for bilateral local currency swaps, which can facilitate cross-border trade and investment in the renminbi. By the end of 2023, the PBOC had entered into agreements with over 40 central banks for bilateral local currency swaps totaling 4.16 trillion yuan.

Pan added that the central bank will keep the renminbi exchange rate generally stable at a reasonable, balanced level.

Huang Yiping, dean of Peking University's National School of Development, said China should also consider providing commercialized investments, low-cost funding and government aid to developing economies to help them bridge the funding gap in achieving a green transition.

Such a scheme would be comparable to the US-sponsored Marshall Plan to rebuild post-World War II Europe, but with a focus on green development. The scheme would be a "win-win" as it would facilitate the global pursuit of carbon neutrality, while helping bolster China's new energy exports and promoting the internationalization of both Chinese financial institutions and the renminbi, Huang said.

Li Zitong contributed to this story.

Contact the writers at zhoulanxv@chinadaily.com.cn