Yuan's journey from the elite reserve currency club to global currency

AMONG the elites, having a membership with a prestigious club signifies one's superiority in terms of his or her social status. Interestingly, a similar club exists for foreign currencies.

Out of the 180 currencies recognised by the United Nations member states as legal tender, only a handful have made it to the Special Drawing Rights (SDR) club of elite currencies. The SDR, introduced in 1969 by the International Monetary Fund (IMF), serves as an international reserve asset to provide liquidity to the global economy which central banks worldwide could use like an overdraft account as and when the need arises.

Prior to October 2016, membership to the SDR club was exclusive only to the United States dollar (USD), the euro (EUR), the British pound (GBP) and the Japanese yen (JPY). Since October 2016, a new kid in town, the Chinese yuan (CNY) has joined the IMF's elite currency club. This new addition to the club since 1999 marked a new phase in China's journey to becoming a more integrated part of the world economy.

Since joining the club, the talk of the town is that the CNY could compete with the incumbent – the USD, and eventually become a key reserve currency to central banks around the world. This journey, while possible, has proven to be challenging – concerns still linger around the governance and development models of the Chinese economy as well as the determination of the CNY/USD exchange rate by the People's Bank of China (PBoC).

As of December 2021, the CNY only constituted 2.79% of global foreign exchange reserves compared to 58.5% for the USD. In terms of global payments, only 2.14% of transactions used the CNY as of April 2022 vis-à-vis 41.81% in USD.

Nonetheless, all is not gloomy for the prospect of gaining the global currency status for the CNY. A combination of factors such as the recent sanctions imposed by the United States on Russia following the Ukraine War, the monetary policy normalisation seen in the world's largest economy which caused appreciation of the USD, China's growing dominance in international trade, and the Belt and Road Initiative (BRI) are all favourable to the internationalisation of the CNY. In addition, an annual reserve manager survey by UBS Asset Management in July 2022 revealed that some 85% of central banks have invested or are considering investing in the CNY.

Though challenging on the global front, countries in the Asia Pacific region are rather receptive to the CNY. In June 2022, the PBoC had signed an agreement with the Bank of International Settlements (BIS) to establish a CNY reserve pool involving Bank Indonesia, Bank Negara Malaysia, the Hong Kong Monetary Authority, the Monetary Authority of Singapore, and the Central Bank of Chile. Each participating central bank would contribute a minimum of 15 billion yuan, or the equivalent of 2.2 billion USD into the reserve pool.

In the event that one of these participating countries faces the issue of insufficient liquidity arising from market volatility, these central banks could draw liquidity from this pool of funds to stabilize its financial system. Additionally, participating central banks could also access additional funding through a collateralised liquidity window by using their existing holdings as collateral.

Such liquidity arrangement entered into by Bank Negara Malaysia with the PBoC and other central banks would have a significant impact in providing confidence to investors that the Malaysian financial system is well-supported even during times of financial turmoil as the country could tap into the reserve pool for additional liquidity when the need arises. Meanwhile, having this arrangement also means that Malaysia will not need to seek financial assistance from the IMF when a crisis strikes.

When a country in distress turns to the IMF for emergency liquidity support, they will be subjected to the IMF's conditionality, where the government would have to agree to certain adjustments in its economic policy to overcome the problem that led to the crisis. While the intention is good, meeting these conditions generally requires some forms of austerity measures, which in turn curtails economic activity and eventually growth too.

In conclusion, for the CNY to be a global currency, there needs to be wide acceptance of the yuan as a reserve currency by central banks worldwide, free trade of the yuan, relaxation of the pegging of the yuan to USD, and greater transparency in PBoC's monetary policy, among other factors. As the Chinese authority works on addressing the above to fully internationalise the CNY, the yuan may be a regional settlement currency in Asia given the growing dominance of China in the region's trading activities as well as economic activities stemming from the Belt and Road Initiative.

Dr Liew Ping Xin is an Assistant Professor at Universiti Tunku Abdul Rahman. The views expressed here are entirely the writer's own.

The SEARCH Scholar Series is a social responsibility programme jointly organised by the Southeast Asia Research Centre for Humanities (SEARCH) and the Centre of Business and Policy Research, Tunku Abdul Rahman University College (TAR UC), and co-organised by the Association of Belt and Road Malaysia.