Je suis Monsieur Yuan
As business, political and academic leaders from around the world gathered in Davos, Switzerland last week to discuss their 2015 global agendas, another Chinese major deal was struck behind the scenes. Zhou Xiaochuan (also known as Mr. Renminbi), governor of the People’s Bank of China (PBC), and Thomas Jordan, Chairman of the Swiss National Bank (SNB) signed an MoU to establish a trading center for the Chinese currency in Zurich. As per the agreement, the Chinese central bank will grant its Swiss counterpart a 50-billion Yuan quota (US $8 billion) under its Renminbi Qualified Foreign Institutional Investor (RQFII) program, launched by Mr. Xiaochuan in 2011. This is an attempt to understand this momentous deal in its proper context in order to unveil its global implications.
In December 2002, Mr. Xiaochuan became the 11th Governor of the People’s Bank of China in what eventually proved to be one of the smartest designations in the country's modern history. Remember the time when everything around you started reading "Made in China"? This was the man behind it! So what exactly did he do that no one else was able to match or copy?
One month prior to Mr. Xiaochuan's appointment, China had introduced the Qualified Foreign Institutional Investor (QFII) program in a first step to internationalize its currency, officially called the Renminbi and more frequently known as the Yuan. Under the QFII program, qualified foreign investors were allowed to buy Renminbi-denominated A-shares in both the Shanghai and Shenzhen stock exchanges. Obviously, all foreign currencies had to be converted to Yuan for settlement.
Then in 2005, Mr. Renminbi took a major step in internationalizing the currency, when he reformed the country's foreign exchange system. The Yuan's peg to the US Dollar, which dated back to 1994, was replaced by a peg against a basket of currencies, while being allowed to float within a "reasonable" range. At the same time, a 2% increase in the currency's rate against the dollar was instantly adopted. Eventually, the Yuan was allowed to appreciate by another 16% before the peg to the US Dollar was temporarily reinstated during the international financial crisis. Two years later, the peg was removed once again as the Yuan gained another 12% against the US Dollar.
The higher Yuan kept Chinese inflation at bay and prevented capital outflows from the country. As a result, Mr. Xiaochuan took his country's exports from as low as $313 billion in 2002, to as high as $2.2 trillion by 2013. Before he took charge, China's exports were growing at average rate of 10% annually. Eleven years down the road, the country's exports have been consistently growing at a 20% average rate except in 2009, when it went negative due to the international financial crisis.
In July 2009, Mr. Xiaochuan launched another pilot program allowing five Chinese cities to settle their cross-border trades in Renminbi. Before this date, the Chinese currency was not allowed outside China's borders; it was simply illegal! The decision meant that a parallel currency, the "Offshore Renminbi", could free float outside the country and outside of China's control, while the local currency remains under Mr. Xiaochuan's supervision. A year later, the pilot program was expanded to include 20 Chinese provinces, before being extended to cover the whole country by August 2011 as the whole world was now allowed to settle trades with China in Yuan.
Then came the big moment, when Mr. Xiaochuan announced the Renminbi Qualified Foreign Institutional Investor (RQFII) scheme in December 2011. The new program allowed qualified jurisdictions – Hong Kong being the first – to buy not just domestic Chinese shares but also Chinese bonds with Offshore Yuan! Now fund managers in those qualified jurisdictions do not have to worry about their currency exposure in China anymore. However, there still remained one obstacle. These jurisdictions needed to accept the new program and implement it locally, before any such transactions take place. The challenge was that by doing so, every single jurisdiction would be officially accepting the Chinese Yuan as an international currency, so did they?
In 2012, Taiwan implemented the program; no big deal, who else would have followed Hong Kong? In 2013, Singapore joined the club; well, this is no internationalization by any means. Now watch this! In 2014, the UK, Germany, South Korea, France, Luxembourg, Qatar, Canada and Australia implemented the program. And if you think that it's still too early for Mr. Xiaochuan to strike any deals in 2015, let it be known that he has already subscribed Thailand and Malaysia earlier this month, and as you already know, Switzerland just signed in Davos!
I know the media is full of strictures on China's policies, but who cared to report that the Chinese currency now ranks second behind the US Dollar as a global financing currency as reported by Swift, the international currency clearing system? How many cared to report that the Yuan surpassed 11 world currencies in just two years to become the fifth most used currency in global trade in December 2014? Make no mistake about it, this is the world's next reserve currency, so don't put all your eggs in the US Dollar. Period!
Note: This is by no means an invitation to sell the US Dollar against the Yuan – actually the Chinese currency is expected to depreciate in the near-term against the Dollar –, it's rather an advice to get ready.