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Could Chinese yuan be set for bigger role as belt and road investors steer clear of US dollar risks?

  • Rising global interest rates and escalating geopolitical tensions, including US-led sanctions, have seen countries shift away from the US dollar

  • Observers expect the belt and road strategy to place more emphasis on Chinese yuan-denominated investment deals

October 15, 2023

Investments under China’s Belt and Road Initiative have historically been conducted in US dollars, but rising global interest rates and geopolitical tensions have seen many borrowers moving away from the greenback.

The next phase of the belt and road could see more trade, financing and investment deals carried out in the Chinese currency as countries try to avoid the risks associated with the US dollar, observers say.

Kanyi Lui, an international project finance lawyer and head of Pinsent Masons’ China offices, said there was likely to be a shift. “I expect much more emphasis on RMB-denominated [belt and road] investments and financing as stakeholders look for ways to mitigate political risk,” he said, using the acronym for renminbi, the official Chinese name for the currency.

Geopolitical tensions, development in technology and debt stress caused by rising US dollar funding costs are likely to make some contraction both globally and in China inevitable as sponsors and investors take time to adjust to the new realities, analysts believe.

This year marks a decade since the setting up of China’s multibillion-dollar transcontinental strategy, with President Xi Jinping set to host the third Belt and Road Initiative International Cooperation Summit Forum opening in Beijing on Tuesday.

In a belt and road white paper released a week ahead of the forum, Beijing revealed that it had signed bilateral currency swap agreements with 20 partner countries and established yuan-clearing arrangements in 17.

Moreover, to increase the international footprint of its currency, China has been encouraging the issuing of cross-border yuan-denominated or “panda” bonds, driven by low yields in the domestic bond market.

The paper noted that China’s securities industry had set up a number of belt and road themed funds and indexes in the eight years since its regulators unveiled a pilot project for overseas institutions to issue yuan-denominated bonds in China’s exchange-traded bond market.

By the end of June, 99 panda bonds with a total value of 152.54 billion yuan (20.9 billion US dollars) had been issued in China’s exchange-traded bond market, as were 46 belt and road themed bonds worth 52.72 billion yuan in all.

Mark Bohlund, a senior credit research analyst at REDD Intelligence, said the shift to Chinese yuan-denominated lending made sense for Beijing.

He said the rapid increase in China’s lending to Africa in the early 2010s came at a time when it was battling pressures on the yuan to appreciate, meaning that it was advantageous to recycle dollar inflows into overseas lending.

The economic situation has now shifted, with dollar inflows and foreign reserves more limited in relation to the size of the Chinese economy. At the same time, China’s ties with the US have become more fraught.

“Many African countries are suffering from a shortage of US dollars, as financial flows have shifted back to the US as the Federal Reserve has hiked rates and longer-term yields have risen sharply,” Bohlund said.

“With China being the major source of imports for most [belt and road] countries, there is also a rationale to have a higher share of renminbi among their FX reserves,” Bohlund added.

A study released last month by BNP Paribas Asset Management, the investment arm of the French multinational lender, said the expansion of Brics and China’s increasing trade and investment flows with Africa were helping to deepen the internationalisation of the yuan.

“With the US increasingly weaponising the US dollar through the usage of financial sanctions, there is a good incentive for African [and other] countries to reduce their US dollar risk and shift to the renminbi,” the study noted.

It said Egypt, a new Brics member with limited access to international capital markets, had in May become the first African economy to issue a panda bond to finance green and social projects. More than 5 per cent of Cameroon, Kenya and Tanzania’s external debt was already denominated in yuan, it added.

In January, China renewed discussions with Saudi Arabia on trading oil in yuan. Brazil, China and Russia – original Brics members and the world’s largest commodity and energy exporters and importers – were already working together on yuan cross-border payments, the study said.

Due to international sanctions, Russia has been conducting most of its trade with China in yuan. Iran, Venezuela and Indonesia have also lately been settling some of their oil trades with China in yuan, according to BNP Paribas.

Yun Sun, co-director of the East Asia Programme and director of the China Programme at the Washington-based Stimson Centre, said if the Chinese used the yuan, the goal was evidently the internationalisation of the currency.

However, she was “not sure RMB is the least risky, given its exchange rate is not always decided by the market”. The lack of convertibility has also hindered its usage as a reserve currency, she added.

“There will be many obstacles, but Beijing could use the opportunity to build … an alternative to the dollar transaction system, in preparation for contingencies,” Sun said.

According to Rolf Langhammer, a professor at the Kiel Institute for the World Economy, “China will probably change the direction of its presence in the Global South from the real sector [trade and aid] to the financial sector.”

He said this would go beyond the use of the yuan as an invoice currency in bilateral trade, but would be targeted to make it an attractive transaction currency and as a unit of account by convincing partner countries to price their commodities in yuan.

“A more important change would be if African countries begin intra-trading using the RMB,” Lauren Johnston, an associate professor at the University of Sydney’s China Studies Centre, said.

“They don’t take each others’ currencies, but they are happy to use the RMB.”

Additional reporting by Kandy Wong



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