China and the global economy

By Janice Roberts

“China is a sleeping giant. Let her sleep, for when she wakes she will move the world.” Napoleon

Economist, Helmo Preuss, examines how China came to prominence in the global economy and the importance of its currency, the yuan.

The process of waking China in terms of global economics only started in December 1978, when Deng Xiaoping announced major economic reforms at the Third Plenum of the 11th Central Committee Congress of the Communist Party of China.

This was in part due to China following an export-led growth model that had been earlier adopted by the Asian Tigers – South Korea, Taiwan, Indonesia, Hong Kong, Malaysia and Thailand. The result was that this sleeping giant became the world’s largest exporter with regular foreign trade surpluses of more than $60bn this year and foreign reserves in excess of $3 trillion.

Deng proposed three steps that would ensure that China would become the world’s largest economy by 2050. The first step was to double the size of the 1980 economy by the end of that decade. The second step was to quadruple the 1980 economy by the end of the following decade, which was achieved in 1995 ahead of schedule. The third step was to increase per capita gross domestic product to the level of the medium-developed countries by 2050.

Under President Xi Jinping, China is aiming to match its economic might by its diplomatic gravitas. The BRICS (Brazil, Russia, India, China and South Africa) grouping plays a significant part in this strategy as the BRICS are as large an economic grouping as the grouping of the most advanced countries, the G 7. This assertiveness is in part due to the election of Shinzo Abe as Japanese Prime Minister in December 2012, as Abe is aiming to increase Japan’s role in global affairs.

The growing importance of China finds its counterpart in how global payments currencies have evolved since January 2012.  Usage of the Chinese yuan as an international payments currency has soared by more than 400% since January 2012. In January 2012 it was only ranked 20th in terms of global payments currencies with a 0.25% share or almost half the rand’s 0.48% share at the time.

Since then there has been a concerted effort to make the yuan (also called the renminbi or RMB) an international payments currency and in December 2012, the yuan moved above the rand in the rankings as the yuan moved to 15th and the rand to 16th. In April 2014 it displaced the Swiss Franc and was ranked seventh with a 1.43% and in June 2015 it was ranked fifth with a 2.09% share having overtaken the Australian and Canadian dollars.

The Crimean crisis in March 2014 saw the South African rand overtake the Russian rouble as an international payments currency, because traders fled from the Russian currency in case more Western sanctions were applied. According to the SWIFT currency tracker, the share of the rand remained stable at 0.42% between January 2013 and April 2014, while the share of the Russian rouble dropped by almost a third from 0.56% to 0.39%. In June 2015 the rand was ranked 15th with a 0.49% share, while the rouble was ranked 20th with 0.22% share. In August 2015 the yuan overtook the yen, while the rouble dropped out of the top 20 to be replaced by the Chilean peso.

So what?

The aim behind the yuan’s rapid rise is to make it part of the International Monetary Fund’s (IMF) Special Drawing Rights (SDR) basket, which currently consists of the US dollar, euro, British pound sterling, and Japanese yen.

SDRs are supplementary foreign exchange reserve assets and the weights of basket of international currencies are reviewed by the IMF every five years with the next review due in December 2015. The weights assigned to each currency in the SDR basket are adjusted to take into account their current prominence in terms of international trade and national foreign exchange reserves.

As part of this strategy the People’s Bank of China announced a “once-off” 1.87% devaluation on 11 August followed by a 1.62% devaluation the next day. The 3.55% devaluation may seem like a small deal when compared with the 20% plus depreciation of emerging market currencies such as the South African rand, Brazilian real and Turkish lira, but the move sparked fears that it could result in a regional currency war because China had lost competiveness due to the softening of Japanese yen and the Korean won over the past year against the US dollar.

The result was that global equity markets swooned and wiped more than $1.5 trillion off market capitalisations. So what happens to the yuan has global implications.

In that respect, the appointment of additional offshore clearing centres outside of Hong Kong has played a key role in driving yuan adoption, with Johannesburg being the most recent centre, showing also how interconnected South Africa is with China.

Keeping track of the yuan is therefore something that asset managers need to do, just as they monitor the rand’s movements against other key international currencies. We expect the BRICS New Development Bank to have some of its capital denominated in yuan and we believe that the first issuance by the South African Treasury of a bond denominated in yuan is on the horizon.

Author: Helmo Preuss of Forecaster Ecosa

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