Why the adoption of the Chinese Yuan as a reserve currency in Africa is causing a stir?
In December, Zimbabwe added the Chinese Yuan (RMB) to its basket of currencies, in addition to the dollar, pound sterling and the rand. This decision follows the International Monetary Fund’s admission of the yuan into its benchmark special drawing rights (SDR) currency basket in November 2015, which will become effective in October 2016. Zimbabwe’s Finance Minister, Patrick Chinamasa, said that Zimbabwe could use the currency to pay its loans to China and the two countries are negotiating on a yuan clearance system.
What are the prospects for adoption of the yuan as a reserve currency on a global level and its prospects in Sub-Saharan Africa in particular? Take the World’s view of the Yuan as a Global reserve Currency first. When the IMF announced the admission of the yuan into its SDR currency basket, the decision was arguably an acknowledgement of China’s rise as a global economic power over the last thirty years. But beyond its symbolic relevance, the inclusion of the yuan in the IMF’s SDR basket is no guarantee that the Chinese currency will become a major reserve currency.
According to the Bank For International Settlements’ Triennial Central Bank Survey, it became the ninth most actively traded currency in 2013, but it only had a share of 2.2% in global FX volumes. Adopting the yuan as a reserve currency poses challenges given limited exchange rate flexibility, convertibility and liquidity. While yuan flexibility has improved, the yuan is far from being a free floating currency: the Chinese central bank still sets a benchmark every morning, the currency is then allowed to move freely with the +/-2% band, while the People’s Bank of China (PBoC) can intervene as it deems necessary. While the central bank has stated that its midpoint mechanism has changed to a more market-based one, the shift to this regime has been uneven at best, and we believe that the daily setting is still very much at the discretion of the PBoC.
Furthermore, while the PBoC announced in December that the yuan would become fully convertible in the provinces of Guangdong, Tianjin and Fujian, it has placed special conditions on this convertibility: corporations should not be engaged in certain sensitive industries on a government “negative list”, and the convertibility will be subject to an annual limit of USD10mn. The bottom line is that full convertibility is not a near-term prospect because China’s banking, stock and bond markets are not ready for such an external shock. Officials have been talking about full convertibility by 2020 but even this may be an optimistic target depending on how deep China’s economic downturn is over the coming years.
While investors in China’s offshore market are not currently allowed to invest in the onshore market, there are signs of progress. First, most of the restrictions that apply to onshore currency trading in China have been lifted in the Shanghai Free Trade Zone. Second, the CNH offshore market, which is dominated by Hong Kong, is expanding quickly. Trading in so-called Dim Sum bonds, or CNH-denominated bonds issued in Hong Kong, rose from RMB200mn in January 2011 to RMB500-600bn in 2013. In 2013, the UK and China agreed to establish direct RMB-sterling trading.
In February 2014, Singapore and London agreed to work together to boost offshore trading in the RMB and in 2014, Paris was authorized to establish an offshore market. But until analysts see a single, considerably deeper RMB market, the main case for the adoption of the yuan is not as a reserve currency per se, but as a settlement currency for countries with a high degree of trade integration with China. In fact, more than 20 central banks have signed swap agreements with the PBoC, which allows foreign central banks to tap a ready source of yuan liquidity to serve the needs of their local markets. These agreements constitute a guarantee that in the event of an RMB shortage, trade can continue through the provision of yuan liquidity and cross-currency risks are reduced.
The Yuan As Reserve Currency In Africa
2014 Merchandise Exports To China, % Of GDP
Source: Business Monitor International, International Trade Center
It is in this trade logic that an increased take-up of the yuan as a settlement currency can be envisaged in Africa, with a view to increase the value of Africa’s bilateral trade with China and that of the infrastructure projects funded by Chinese loans. China accounts for about 20% of imports in Sub-Saharan Africa and about 15% of its exports. But using the yuan as a settlement currency makes the most sense in the sixteen African countries that send more than 20% of their exports to China and even more so in the seven, including Sierra Leone, Eritrea, Republic of Congo, Angola and Sudan, for which China accounts for 40% of total exports.
China is also the single largest investor in African infrastructure, so that yuan settlement would also make sense here. The fact that currently these China-Africa transactions have to be converted into dollars increases their costs. Further still, the RMB offers a higher yield than traditional reserve currencies. Sure enough, a series of African countries other than Zimbabwe have already added the yuan to their reserves. Ghana, Mauritius and Zambia are amongst them. Nigeria had just USD28.7bn in foreign exchange reserves at end-2015, and 10% of these reserves are in yuan. CBN Governor Godwin Emefiele said in March 2015 that he was planning to shift more of the country’s reserves from dollars into yuan. In July 2015, South Africa became the first African country to host the first yuan clearing house on the continent, three months after central banks in China and Africa inked a three-year bilateral agreement for the swap of local currencies of up to USD4.8bn.
In June 2015, almost a third of payments between South Africa and Greater China were settled in Chinese yuan, implying a tripling of flows in the last two years. The National Bank of Kenya soon followed up with its own clearing house as did that of Ghana. Tanzania and Kenya also plan to include yuan into their list of reserve currencies in 2016. For the moment, African central banks can either choose the offshore RMB for simpler and quicker entry, as the Central Bank of Nigeria has done, or the onshore RMB which offers a higher yield, as the South African Reserve Bank has done. Yet the higher onshore yield should eventually come down as yuan internationalisation proceeds.
In Kenya, Standard Chartered Bank passed its own the vote of confidence in the Yuan, through their CEO, Lavin Manjang, as he told a group of StanChart clients that last year’s decision by the International Monetary Fund (IMF) to add the Renminbi, also known as the Yuan, to its ‘Special Drawing Rights’ basket was positive for Africa-China trade. Mr Manjang said the adoption of the currency by local companies and traders in Africa and the Middle East has been gradual, but positive.
“Importers and exporters who use the renminbi have the opportunity to mitigate risks and reduce costs associated with the three-way foreign exchange from Kenya shilling to the US dollar then Chinese yuan when trading with China,” said Mr Manjang adding that “we expect suppliers to lower their prices to reflect lower foreign exchange costs.”
The debate on the Yuan is likely to spiral into the near future, as analysts observe the constraints in convertibility and special conditions on trading the currency in China are lifted – one thing for sure though is this, the huge impact that the currency will have if adopted across many world economies as a reserve or trading currency is not in doubt.
The author is a Kenyan Certified Investments and Financial Analyst and Actuarial Science Graduate, he is also a passionate and Africa-focused Corporate Banker. He can be reached at email@example.com