Is China trying to replace USD with Yuan?

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China wants yuan to replace USD in the global market but first China has to make it a strong reserve currency. That would give China the following benefits.

1.      There would be lower interest rates for bonds denominated in yuan as all central banks have to hold yuan as their foreign exchange reserve and there will demand for yuan.

2.      Lower borrowing cost for Chinese exporters.

3.      China would not have to worry about the US dollar value.

Reserve currency – Reserve currency or anchor currency is held by the central bank as foreign exchange reserve.

Chinese yuan became a world reserve currency on October 1, 2016. It represents 10.92% of the IMF's special drawing rights currency basket. The Chinese yuan is the 3rd reserve currency after the US dollar and Euro within the basket of currencies in the SDR (Special drawing rights) which is a fraction of the total reserve currencies in reserves today. SDR is an artificial currency instrument used by the International monetary fund (IMF) and it is built from a basket of important national currency.

China is trying its debt-trap diplomacy to globalize yuan and trying to replace US dollars. Debt trap diplomacy is a foreign policy of china in which china give loans low-income countries and middle-income group countries generally African countries. China lends a huge amount to these countries and when a country is unable to pay its loan China becomes a major stakeholder in its economy.

External Debt to China(debt stocks as a share of country’s GDP)- TOP 5 recipients

1. Djibouti – 88%

2. Tonga – 40%

3. Maldives – 35%

4. Congo rep. – 33%

5. Kyrgyzstan – 32%

Since most African regions have loans and grants for from China, so repaying then in Yuan make economic sense for these countries. Yuan has become common currency for trade in Africa.

China is the largest trading partner for over 130 countries. So many countries are swapping their US dollar to Yuan as a currency reserve.

·         European Central Bank said that it had exchanged €500 million ($611 million) worth of US dollar reserves into yuan securities, signaling confidence in Yuan. It shows the growing importance of Yuan in the global financial system. The investment in Yuan was made by changing the current composition of the European central bank foreign reserves. The ECB sold a small portion of its US dollar holdings, leaving the overall size of the ECB’s foreign reserves unchanged.

·         Nigeria-China currency swap agreement –In this Agreement trade between Nigeria and China will be done in Yuan. Mainly, the Currency Swap Agreement wants to create a platform that provides Naira (Nigerian currency) liquidity to Chinese firms; and also provides Chinese Yuan liquidity to Nigerian firms. The Currency Swap Agreement is made to aid trade transactions between China and Nigeria and remove the need to first source for the US dollar before payments for transactions involving the two countries can be made.

This shows how China is using Foreign policy to make Yuan a dominant currency in the world.

Presently Yuan is far from replacing the US dollar. China has to meet the following conditions to replace US dollars.

  1.          All the central bank of the world keep 700 worth of yuan as foreign exchange reserve
  2.         China’s financial market should be transparent.
  3.         There should be a stable monetary policy in China.

Thank you.
Regards,
Niyanta Khare,
Kautilya,
IBS Mumbai.                                                 

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