Will US debt ceiling deadlock push capital to yuan market?

Illustration: Carlos Latuff

Expert: The role of the U.S. dollar declines

The US Government is BROKE | The 2023 Debt Ceiling

Every few years, there is a bipartisan political farce over the debt ceiling negotiations in the US. It may look like a routine political drama, but quantitative change can lead to a qualitative difference, especially at a time when a global de-dollarization trend is gaining momentum, that is to say, the US trick of raising the debt limit to mitigate its default risk may now be very close to pushing the US treasuries to a dangerous tipping point.

The de-dollarization caused by the US debt crisis and the abuse of the dollar hegemony created unprecedented opportunities for the yuan internationalization, with more and more countries expressing willingness to settle trade in the yuan, but China must proceed with caution.

With the US on track to default without a debt ceiling increase, US President Joe Biden's talks with House of Representatives Speaker Kevin McCarthy on Tuesday failed to make any meaningful progress, with political divides remaining between the two parties, Reuters reported. Biden even told the media that he has been looking at the 14th Amendment as a way to unilaterally work around the debt ceiling, though it will not be a viable short-term solution.

The political stalemate over raising the debt limit has already led to US Treasury Secretary Janet Yellen warning of an "economic catastrophe" if the US fails to meet all government payment obligations, which could happen "potentially as early as June 1."

So far, most people still believe that the two parties will eventually reach a deal to avoid an ugly sovereign default before the deadline, just like what happened every time in the past debt ceiling struggles.

But unlike in the past, a new question has been raised in the market, that is, are the US treasuries still highly liquid? The US dollar's credit is the cornerstone of US treasuries. Because the dollar is an international settlement currency and US treasuries have stable yields and are highly liquid, countries are willing to hold US debt, making the US the world's largest debtor.

Yet, things may be different now with countries accelerating their de-dollarization efforts. The past year saw growing number of countries and regions such as India, Brazil, and the EU trying to establish new settlement systems for their trade.

Under the influence of the de-dollarization wave, some countries have reduced their holdings of US treasuries. Japan, the world's largest holder of US debts, slashed its holdings by $224.5 billion and China by $173.2 billion in 2022.

Moreover, the US' unlimited expansion of the size of its debt has also upset the market with the risks in the US treasuries. According to Yellen's testimony in a congressional hearing in March, gross federal debt would swell to $51 trillion after a decade. The scale and speed of the debt expansion means the US is getting increasingly closer to a real explosion of a debt crisis.

Also, the root cause of the US banking crisis this year is the holding of a large number of US treasuries assets, which shrank significantly in value as interest rates continued to climb. That could be a warning to various governments and precipitated them to speed up the pace of de-dollarization. Since the collapse of the Silicon Valley Bank, international investors stepped up sell-off of treasuries, and prices of all kinds of safe-haven assets like gold have surged.

Of course, de-dollarization is likely to be a long-term process, but once it started, the US treasuries could lose its aura quickly, especially as the US government repeatedly raises debt ceiling or faces risk of default. In other words, as the world realizes that the US cannot and does not have the willingness to control or reduce the size of its debt, the credibility of the US debt as a safe-haven asset is collapsing rapidly.

It should be noted that amid the de-dollarization trend, the yuan internationalization has made a series of positive new developments and breakthroughs. The yuan's international status as a trading currency has been significantly improved recently.

To ensure future development of the yuan internationalization, China needs to ensure liquidity and maintain exchange rate stability. Thus, China's financial markets as well as the yuan's onshore and offshore markets need more preparation to adapt to the new needs. 

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Malaysia taps into the growing importance of the redback:Yuan

The Society for Worldwide Interbank Financial Telecommunication says yuan usage worldwide grew 15.6% between July and August this year.

MALAYSIA’S love affair with the yuan or renminbi is growing, and it is easy to see why.

For one thing, China’s economic clout is rising. It is now the second largest economy in the world, and with ongoing financial reforms by the Chinese government, the yuan is expected to eventually rise to match the country’s economic stature.

For another - and more importantly - China has, in recent years, been growing to be an increasingly significant trading partner to many economies in the world, especially in Asia, including Malaysia.

Bilateral trade between Malaysia and China, for instance, is now seven times higher than it was 20 years ago.
And China has emerged as Malaysia’s largest global trading partner since 2009.

Last year, Malaysia’s total trade with China was valued at RM167bil, up 14% from the preceding year, and accounting for 14% of the country’s total trade.

The Government expects the value of Malaysia’s total trade with China to double in the next five years.

China’s rising prominence, in Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz’s words, presents “a new operating environment” that requires “dynamic response”.

At a recent seminar entitled “Renminbi Trade Settlement and Investment”, Zeti said one of the changes that would shape the international financial system in the years to come was the wider role of the yuan in trade and finance.

As it is, such trend is already taking shape, with yuan usage across the world increasing progressively.

Wider yuan usage 

According to Society for Worldwide Interbank Financial Telecommunication (SWIFT), yuan usage worldwide grew 15.6% between July and August this year, compared with an average decrease of 0.9% across all other currencies. SWIFT further noted the yuan has moved up one position to be the 14th mostly used world currency, with a market share of 0.53%, up from 0.45% in July 2012.

Standard Chartered plc’s report supports claims that the global use of yuan is on the rise, for trade settlement, in particular.

The international bank notes that Asian and European firms, led by those from Singapore and London, are increasingly open to using yuan.

“We see many European and Asian clients shifting away from settlement in US dollars,” Standard Chartered’s Hong Kong-based foreign exchange analyst Eddie Cheung wrote in his report.

Reports by foreign media suggest that yuan trade settlement could run between US$350bil and US$450bil this year, up from US$300bil last year.

It is understood that China is also quietly working on developing new yuan financial centres around the world to expand the international use of the currency.

At present, Singapore and London are the only cities outside Hong Kong that have been allowed to serve as yuan trading centre. China is reportedly planning for the next regional hubs for settling trade deals in yuan to be set up in Latin America and the Middle East.

As part of an initiative to encourage a wider use of its currency and to manage volatility in uncertain economic times, China has been actively seeking to establish ilateral swap agreements with foreign central banks since the onslaught of the global financial crisis in 2008.

To date, China has managed to set up 20 bilateral local currency swap agreements, worth a total of 1.6 trillion yuan (RM780bil), with central banks of countries within and outside of Asia.

This list includes Malaysia, South Korea, Iceland, Argentina, Pakistan, the United Arab Emirates, Turkey and Australia.

China’s bilateral swap agreement with Malaysia is worth 180 billion yuan.

Zeti notes that Malaysia’s trade settlement in yuan is still at a paltry 1% of the country’s bilateral trade with China. “There is, therefore, a significant potential for this to increase,” she says.

Bank Negara is currently on a mission to promote a wider use of yuan for trade settlement and investment among Malaysian corporations as a way to generate cost savings and minimise exchange rate risks.

“A wider use of yuan is only a natural progression, led by China’s rapidly expanding trade volume and its increasing role as the driver of global economic growth,” explains RAM Holdings Bhd group chief economist Dr Yeah Kim Leng.

“For Malaysian businesses with yuan obligations, the shift to the use of yuan will provide a natural hedge and help them reduce risk and lower cost,” he adds.

According to Zeti, Malaysia’s interest in yuan is also notable in the investment option, with yuan deposits in the country’s banking system having tripled within the first seven months of this year.

Focus on Dim Sum bonds

Meanwhile, there is also an ambition to promote Malaysia as the next hub for yuan-denominated debt (or popularly known as “Dim Sum bonds”) in Asean after Singapore. This is led by the growing interest in raising financing in yuan to meet funding requirements.

“Malaysia is well-positioned to realise this growth potential in yuan-denominated bond and sukuk, given our market size and supporting infrastructure,” Zeti argues.

She, however, says the number and timing of yuan-denominated bond and sukuk issuances will depend on the approvals of Bank Negara and the Securities Commission.

To date, there are only two issuances of offshore yuan-denominated sukuk out of Malaysia and a yuan-denominated bond issuance by Malaysian corporations.

“Ultimately, the potential of Malaysia of becoming a regional yuan debt hub will have to be led by natural market forces, that is, supply and demand,” Yeah points out.

At present, Europe, led by Luxembourg, outstrips Asia (excluding Hong Kong) in terms of both the number of issues and the number of issuance locations.

Analysts, however, believe Asia (excluding Hong Kong) will soon catch up.

Anchor currency

According to the Asian Development Bank (ADB), the yuan will eventually become the “anchor currency” for Asia.

This destiny is cemented by the growing use of the currency in the region’s trade and financial markets.

This, however, does not necessarily mean that the yuan will become part of the foreign exchange reserves of Asian countries, most of which still hold US dollar, euro and the Japanese yen, says ADB. Rather, it means that countries that use yuan widely will manage their currencies according to the yuan’s movement.

The consensus view is that there is still some way to go before the yuan can become a reserve currency. That will involve further openness of China’s own financial markets.

At present, the yuan has yet to qualify as a reserve currency due to its lacks of full convertibility as defined by the International Monetary Fund.

Nevertheless, many central banks have already started to diversify their reserves into the yuan. One of these is Bank Negara, which became the first central bank in the world to announce the inclusion of yuan in its foreign reserves in 2010.

It has been five years since China embarked on a plan to internationalise its currency.

Analysts argue that the process of internationalising the yuan is already progressing smoothly, but gradually in a managed way.

In their working paper entitled “Will the renminbi rule?” authors Eswar Prasad and Lei Ye argue that although China still has extensive capital controls in place, they are being “selectively and cautiously dismantled”.

“China’s capital account is becoming increasingly open in actual terms even though by this measure it remains less open than those of the reserve currency economies – the euro area, Japan, Switzerland, the UK and the United States,” they argue.

According to CIMB Research chief economist Lee Heng Guei, China has taken small yet quite successful steps in its quest for internationalisation of the yuan.

However, he says, full-fledged internationsation of the yuan is a still a distant goal.

“China is clearly more influential than in the past and the internationalisation of the yuan has sped up. But it will take many more years, perhaps another five to ten, for the yuan to be fully global and convertible,” Lee argues.

Undervalued or not?

Now, China’s currency policy has for long been a contentious issue with many western developed nations, especially the United States. There has been growing political pressure on China, led mainly by the United States, to increase the value of the yuan.

The United States has been arguing that the yuan is significantly undervalued, hence giving China’s exporters an unfair price advantage over US manufacturers.

The undervaluation of yuan, which, to some, warrants China being tagged a currency manipulator, has even become an important scoring point in the current US presidential campaign between Republican candidate Mitt Romney and incumbent Barack Obama.

A semi-annual report on the yuan by the US Treasury is due to be released on Monday.

It remains to be seen whether the release of the report will be delayed until after the Nov 6 US presidential election, given the political sensitiveness of the issue.

To be fair, since the yuan’s depeg from the US dollar in July 2005, the Chinese currency has appreciated more than 30% against the greenback.

And reaffirming its policy stance of further exchange rate flexibility, the Chinese government in April widened the trading band from +/-0.5% to +/-1% for the yuan against the US dollar.

Peterson Institute for International Economics estimated the yuan four years ago was undervalued by 31.5% against the US dollar. The latest estimate by the Washington think tank in May indicates that the yuan is now undervalued by only 7.7% against the greenback.

CIMB’s Lee contends that the yuan’s appreciation has to be a gradual and longer-term affair to avoid disrupting China’s economic development.

“The gradual and consistent yuan appreciation can be considered a stabilising factor for the (Chinese) economy, especially its export-oriented sector,” he explains.

According to the Royal Bank of Scotland, the yuan’s value is unlikely to change much in the short term, but further medium-term appreciation on account of productivity catch up remains a possibility.

“If the global economic outlook improves in 2013, the yuan is likely to see further medium-term strengthening, with the pace depending on current account developments,” RBS’ Hong Kong-based analyst Louis Kuijs notes.

By CECILIA KOK
cecilia_kok@thestar.com.my


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