Invest in the Global Yuan

March 20, 2015

I am teaching a course on International Business here at Georgetown University. This Spring, we have concentrated on writing editorials on international business and trade issues. All my students have written and handed in one editorial dealing with an issue of their concern. I was very impressed by their work, particularly since these young tigers, as we call them here, are the ones ascending in their societal position. They will be the ones running their families firm, electing the next government, and deciding what their aging parents should do. So to my mind, their opinions matter.

Take a look:

by Kevin Ma

Near the end of this year, the International Monetary Fund’s (IMF) will consider adding the yuan to its in-house basket of currency reserves. The basket, called Special Drawing Rights (SDR), represents claims on reserves that the IMF holds and allocates to member nations. The approval of the yuan would mark a significant step in an ongoing process by China to increase the international presence of its currency, also called the renminbi (RMB), and would put it on par with the other SDR currencies. Currently, the SDR basket consists of U.S. dollars, Euro, pound sterling, and Yen, which the IMF reports as 47%, 34%, 12%, and 7% of the distribution, respectively.

When the IMF reviewed the SDR basket five years ago in 2010, the international organization denied China’s push to include the yuan due to the currency’s lack of convertibility. In other words, it wasn’t widely used enough to be considered freely useable. Since then, China has made substantial efforts to meet the IMF’s convertibility criteria and has resulted in significant internationalization of the currency. Already, China has established 15 offshore clearing centers—in cities including London, Hong Kong, Switzerland, and Sydney—as well as swap agreements with 28 central banks. Last November, the global payment provider SWIFT ranked the RMB 5^th in the list of currencies used most in trade, up from 21^stthree years ago.

The rapid rise of the yuan’s popularity in the global market is hard to ignore, but should you invest in it? For the globally minded investor, the answer is a resounding yes.

Having only opened its economy to international trade four decades ago, China ranks as the world’s second largest economy, which carries with it an abundance of opportunity for investors. These opportunities have typically been restricted to outsiders, international investors have seen an increasing amount of access to Chinese capital markets and direct investment in recent years. Under the country’s Renminbi Qualified Foreign Institutional Investor (RQFII) program, China has already allowed ten countries to purchase RMB-denominated “A-shares,” which represent China-based companies traded on the mainland stock exchanges and had originally been limited to domestic investors only. Last year, China also became the largest recipient of foreign direct investment, with net inflows of $128 billion, while the United States’ inflows fell by two thirds to $86 billion, according to the United Nations international trade body (UNCTAD). As China continues to make the yuan more freely usable over the coming years in hopes of maintaining sufficient convertibility for inclusion in the SDR basket, investors will likely enjoy much wider access to the nation’s markets.

The benefits of a more convertible yuan aren’t restricted solely to investments within China’s borders. The greater prevalence of the yuan in world markets has also enabled Chinese investors to bring their capital abroad. The many Chinese companies that seek investments outside their country are more able to trade in their own currency instead of converting revenues back into the yuan through the foreign exchange markets. Chinese companies would be less susceptible to volatility in foreign exchange prices and thus have more incentive to invest internationally. For other nations, this would mean access to an abundant source of capital. The Chinese government reported that, in the past year alone, outbound direct investment grew more than 14% to $102.9 billion.

The European Union has been a major beneficiary of outbound investment from China. At the peak of the EU debt crisis, while most investors fled the continent and took their money with them, China-based companies surged into some of the hardest-hit countries and provided cash when others would not. Many of China’s European trading partners have benefited from the yuan’s internationalization, which has provided access to China’s mainland markets as well as capital from Chinese investors. As a result, the UK, Germany, and France are all competing to become the European hub for Chinese investment and yuan trading.

Some may worry that globalization of the yuan will lead businesses to be more susceptible to the influence of the Chinese government, which has typically maintained a tight control over its national economy and currency. This concern, however, is why investing in the yuan is all the more important. As international businesses take advantage of the growing accessibility to China’s markets, the nation’s government will be inclined to continue efforts to bolster global confidence in the yuan’s convertibility.

Within the near future, one can reasonably expect the yuan to play an increasingly dominant role in international trade. Should the IMF accept the yuan into the SDR basket later this year, China and its currency will become even larger players in the world market. For the global investor, now is the time to take advantage of this trend and become a part of the rapidly growing yuan market.