Africa: The Vanguard of Yuan Internationalization?

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YuanGlobal stock markets rebounded in the second full week of September after Italy said it was negotiating with Chinese officials for a bond purchase. Success in those negotiations would be the second time in as many months that China has brought back investor confidence on the bonds of troubled peripheral euro zone countries. Market watchers said they weren’t surprised and they expect more of the same to come.

With a 9.5 percent gross domestic product, compared to anemic growth in the United States, Europe and Japan, China is no longer the world’s factory. Instead, it has become the engine of the world’s economy. Its currency, the yuan, also known as remninbi, is the only one among the world’s major currencies that has strengthened against the U.S. dollar so far this quarter, and yuan-denominated notes in China are the only bonds among the big emerging markets that provide good returns.

China is now promoting use of the yuan as a global reserve currency to ease the impact of any future financial crisis, throwing a direct challenge to the dollar. As a first step, Chinese officials have taken a range of measures to boost Hong Kong’s status as an offshore yuan center, including rules allowing holdings of the currency in the city to be used for foreign direct investment in China.

They are also luring major Western banks such as HSBC and Standard Chartered Bank to relocate their headquarters to Hong Kong from London. Yuan-denominated accounts are now on offer to regular customers in London and New York City in a move to expand the currency’s global reach. The Bank of China says customers of its Chinatown branch in New York will be allowed to trade yuan for dollars and can wire yuan to or from China.

So far the efforts are beginning to bear fruit. Some reports say a number of central banks plan to start buying yuan once China allows conversion of the currency for investment while slowing global growth spurs the U.S. and Europe to keep interest rates below 2 percent. Britain and China have agreed to develop a yuan offshore market in London, British finance minister George Osborne said this month, joining Singapore and Taipei, which are jostling for a share of the growing offshore yuan business.

Nigeria, Africa’s top oil producer and the continent’s most populous country, earlier this month announced that it will shift 10 percent of its foreign reserves into yuan as soon as possible, on bets the currency will appreciate because of China’s well managed economy. That represents $3.3 billion of Nigeria’s $32 billion total foreign exchange reserves. That’s a small amount of money, but the move by Nigeria is an important step for China.

Nigeria decided to diversify its foreign exchange reserves earlier this year with help from China. The Nigerian central bank is also looking at investment opportunities in the offshore yuan market in Hong Kong, where the currency is fully convertible.

Those moves show that the yuan, which was pegged to the dollar nearly a year ago and managed more recently to keep Chinese exports cheap, is slowly turning into a global reserve currency. Africa, potentially the easiest area of success for practical reasons, may well be China’s beachhead in the vanguard of yuan internationalization.

China’s importance as a trade partner is growing across Africa. Beijing expects trade with the continent to exceed $110 billion this year, mostly on commodities and construction. One is likely to come across cranes at work wherever one goes on the continent as the Chinese build roads, bridges and engage in other major infrastructure projects, including government offices in Kenya, Uganda and Ethiopia.

So far, Nigeria is the only African country known to have shifted a portion of its currency reserve holdings to yuan but it may not be the last. If successful in Nigeria, the Chinese are likely to turn to other financial centers on the continent: South Africa, then Ghana, Angola, and Kenya.

Countries elsewhere have are also attracted by the yuan. The Philippines and Thailand are considering converting some of their reserve dollars into yuan. Philippine Finance Secretary Cesar Purisima said earlier this month that buying yuan may be “prudent.”

The Inter-American Development Bank, which lends funds to 26 Latin American countries, also announced plans on Sept. 15 to launch a pilot $25 million program to finance yuan trade settlement by the region’s companies. For Latin American countries, settling trade in yuan is an opportunity to move away from reliance on the U.S. dollar, which currently is used in about 90 percent of trade between Latin America and the rest of the world.

There are a few drawbacks for the yuan, however, and African central banks rushing towards Beijing should be wary of these. For example, China limits the conversion of its currency for investment purposes, increasing the risk of holding yuan securities as assets to tap in an emergency.

In addition, while the yuan may be growing more popular for trade, having it as the global reserve currency over the dollar is unrealistic at this moment because of the lack of investment channels from which banks can choose. While the dollar is accepted everywhere, the yuan still can only be invested in China.