Yuan 2020: Buy or Sell?

July 1, 2015

A recent report by the Society for Worldwide Interbank Financial Telecommunication (SWIFT) says that China’s national currency got firmly established in the top 5 of the most used currencies of the world’s economy. Moreover, the share of yuan payments globally has been rising sharply and exceeded 2 percent. Even more impressive is the value of yuan transactions in international trade – one of these days it will surpass 10 percent.  

Over the past five years, the yuan has turned into a major regional currency, primarily due to China’s trade integration with the main developing markets. In East Asia, there’s actually a bloc of countries that have pegged their national currencies to the yuan more than to the US dollar.  They include Indonesia, Malaysia, Singapore, Taiwan, Thailand, the Philippines and South Korea.

The Economist Intelligence Unit (EIU) forecasts that by 2020 China will become the world’s second largest economy and Chinese population’s purchasing power will basically catch up with that of the United States.

HSBC experts echo the EIU opinion, albeit with an important reservation – The yuan is set to become a major world currency quite soon. However, it doesn’t mean that the yuan will replace the US dollar as a dominant reserve currency. Instead, it will help to create a more comprehensive system of reserve currencies, with the dollar, the euro and the yuan playing their respective part. 

Pundits from the Peterson Institute for International Economics (Washington, USA), one of the most renowned think tanks focused on international economics, say that the yuan would need 10 to 15 years to turn into a full-fledged reserve currency alongside the US dollar. Towards this end, China has to carry out a number of reforms and first of all open up the foreign and finance sectors of its economy.  

Standard Chartered finance gurus differ on this and believe that by 2020 China won’t just catch up with the US economy but overtake it.   

NordFX leading analyst John Gordon weighs in, “With this said, the key question is whether China’s government would want to deal with all the issues pertaining to turning the yuan into a global currency. On the one hand, China is obviously interested in becoming less dependent on the dollar but, on the other hand, it can be achieved only by loosening restrictions on its foreign exchange and capital markets at the very least. The fixed exchange rate shields the yuan from external speculative attacks. What will happen if this protection goes down and the yuan trades freely? Would China really want to see this rather risky process through?”

It’s no secret that from the very start of his first presidential term Barack Obama tried to put pressure on the Chinese government to quit devaluing the yuan rate artificially.  But if the yuan is traded freely, Chinese products will get much more expensive, which, in turn, will hurt their competitiveness abroad and substantially change China’s export-orientated economy. Will Chinese leadership venture on this path?

“At NordFX, we closely watch everything related to financial markets, – continues John Gordon. – Judging by the latest rhetoric, Chinese authorities sound very decisive. It would suffice to recall that Yi Gang, Director of the State Administration of Foreign Exchange and Deputy Governor of the People's Bank of China, announced that China had already started talks with the IMF about including the yuan into the global reserve currency basket in the near future.”   

According to this high-ranking official, the yuan meets all IMF requirements at this time. Hence, it appears that the issue has to do more with politics rather than economy.

As far as the Forex market is concerned, the main factor here is exchange rate fluctuations. Debating a five-year investment horizon for the yuan, many analysts predict it would rise by 15-17 percent. However, Yi Gang’s interview with Bloomberg in Beijing highlights two important things. First and undeniable is that the Chinese currency has been very stable over the last few years, and the other and thought-provoking is the assurance that the yuan will remain as stable in the future.   

What’s also noteworthy is three main directions of China’s policy singled out in a Financial Times article:

- China tends to purchase fewer US Treasurys;

- China broadens its overseas expansion program;

- promotion of the yuan as a global currency is encouraged as it gradually sets China free from the dollar.

The Financial Times article seems to imply that the era of boundless privileges for the USA as the emitter of the main global currency is coming to an end. It is going to be replaced by a dual currency world – the US dollar and the yuan. However, due to the fact the yuan exchange rate was, is and will be fixed by the Chinese government for a while, the profitability of long-term yuan investments is rather questionable. Nonetheless, considering limited and controlled volatility, short-term speculations may actually appeal to traders.     

 

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