Yuan internalisation: curb your enthusiasm

Remember all that excitement last year about the internationalization of the yuan as deposits in Hong Kong doubled from their level at the end of 2010 and the visiting Vice-Premier Li Keqiang promised three dozen regulatory changes to boost Rmb business. Western companies lined up to issue dim sum bonds. Trade settlements in yuan were, it was believed, bound to be boosted by the Mainland’s global commerce. As usual when there is an upside to be glimpsed from China, exuberance took over.

Now reality is exerting itself. After rising all year, yuan deposits in Hong Kong dropped in December as importers paid suppliers in yuan. Also, expectations of strong appreciation were dimmed by China’s worries about the impact on exports of the downturn in Europe which may well lead to the currency staying flat through the first half of this year.

Yuan deposits in Hong Kong January 2008-December 2011

As Trusted Source’s chief economist Larry Brainard pointed out in a report in June, the rapid growth in offshore yuan deposits in Hong Kong was driven by the asymmetry in trade settlements permitted under 2010 reforms of China’s FX regulations. Since it is matched by a similar rise in China’s official foreign exchange reserves, it simply swells the Mainland’s treasure trove even further. Beijing may reckon that the internationalization of the yuan increases its leverage in international financial reform discussions, but does it really want a fresh channel to raising reserves that mire it even more deeply in the dollar trap? There is a conspiracy theory that the whole policy is a dodge by frustrated reformers using it to force change in China’s domestic financial system, but that is a pretty tortuous notion.

Indeed, one may ask how far Beijing wants to push the process. Two well-placed sources have told us recently that full internationalization is “a 10-year thing” or will be a matter for the Sixth Generation of China’s leaders, who take office in 2022. The key issue remains the incompatibility between internationalization and currency controls, and Beijing shows no signs of wavering on the latter. Plans announced by the National Reform and Development Commission this week to boost Shanghai as an international financial hub by 2015 point in the opposite direction.

The plan would make the daily yuan mid-point published by the central bank in the onshore yuan market the benchmark for foreign as well as domestic yuan trading markets, thereby asserting Beijing’s control over Hong Kong and preventing market-driven variations. The government-backed Shanghai Interbank Offered Rate (Shibor) would be the benchmark for all yuan credit everywhere. In other words, for all the talk, control remains the central concern, as so often in an economy driven by politics. As for internationalization, expect the evaporation of euphoria.