China may balk at pissed-off reserves chasing yuan: Mike Dolan

LONDON, March 18 (Reuters) – The Chinese yuan is not yet in a great position to absorb a significant share of global central bank reserves if other central banks were to be unnerved by the freezing of Russian assets abroad.

And many investors doubt that China can handle them or even want them right now.

The yuan is still not fully convertible overseas and letting it float now, while potentially attracting hundreds of billions of dollars in reserves, would risk the kind of severe currency overvaluation that Beijing has spent decades resisting. .

China has a long-standing goal of greater “internationalization” of the yuan – but its mantra of seeking stability would likely prevail for the foreseeable future. And after a year of hyperactive financial interventions and regulations, Beijing seems in no rush to liberalize the markets.

Thinly concealed official alarm this week over wild swings in Chinese stocks – rattled by new COVID lockdowns, soaring energy costs and continued financial and trade ties with heavily sanctioned Russia – has pushed the government to promise more support and even to point out some rollbacks from its recent regulatory zeal.

In light of all these series shocks, an exchange rate battle may not be Beijing’s priority.

And yet, if the yuan were to suddenly make up just 10% of the world’s nearly $13 trillion central bank reserves – something many analysts had only expected for about a decade – it would have to nearly quadruple its current share of 2.6%.

That equates to roughly $1 trillion in additional overseas liquidity placed in foreign currency and yuan assets, more than all foreign inflows into its stocks and bonds since 2019.

Unless it is fully offset by direct intervention from China to sell yuan and build up even more liquidity reserves that other central banks were losing, this flow could be swamped.

As asset manager DWS wryly noted this week: “China is not brimming with energy at the moment.

And so, even though people see the yuan as the only realistic counterbalance to the dollar and the euro and a handful of other reserve currencies, they still see the status quo persisting.

“To replace the United States as the global currency issuer, China would have to make the (yuan) renminbi fully convertible, which in turn would require a much deeper liberalization of its financial system and economy,” said Sonal Desai, CEO. Head of Investments at Franklin Templeton Fixed Income.

“Instead, in recent years Chinese policymakers have tightened their control over the economy.”

Morgan Stanley strategists, who before the Russia-Ukraine clash saw the yuan’s share of reserves rising only gradually to reach 10% by 2030, also doubt a sudden change in the dollar’s status.

“It is not clear that recent actions have undermined the idea of ​​the dollar as the safest global reserve asset and it may well remain the dominant global currency for some time to come, albeit at levels slightly lower than before.”


So why these doubts about the status of the dollar anyway?

As part of the sweeping financial sanctions against Russia, the governments of the G7 and the European Union crippled more than half of the central bank’s $640 billion in foreign currency and gold reserves at the end of last month. Russian.

While countries like Iran, Venezuela and – more recently – Afghanistan have faced similar sanctions in recent years, the economic powers have never frozen the reserves of another incumbent G20 member and of the Bank for International Settlements.

Currency managers have since been abuzz over what some call a ‘weaponisation’ of central bank reserves could mean for the nearly $13 trillion parked in government deposits and bills and bonds of major currencies. reserve.

The question is whether some countries that are not closely allied with the G7 might fear that their holdings in Western markets will be less secure in the event of a future clash.

The dollar and the euro represent almost 80% of these world reserves, while the pound sterling and the yen represent another 10%.

China is by far the largest holder of reserves, with a reserve of $3.4 trillion – a sign that China still does not consider its domestic economy and financial system strong enough to absorb unhindered foreign capital without distortion. major.

Before the Russian freeze, it, Brazil, India and China plus Saudi Arabia accounted for more than 40% of global reserves.

Playing on the possible fallout, investors have considered everything from quickly diversifying reserves to big sales of US Treasuries or German Bunds, to hoarding metals and commodities or even stopping storage altogether. reserves.

But the chance of the Chinese yuan taking over dominates many investor calls, with reports this week that Saudi Arabia wanted to price some of the crude oil it sells to China in yuan instead. only in dollars.

If the pandemic and the war in Ukraine now lead to a more polarized world of two different economic and political blocs, where China becomes an alternative anchor, some suggest that reserve managers may eventually have to follow suit to balance the differences. risks.

But whatever the timeline, it assumes China sides with Russia and actively avoids a dollar trading system.

DWS believes this week’s market volatility illustrates how China has its own issues to deal with and knows it still relies heavily on major Western markets for much-needed growth.

“We think this scenario is implausible, or at least extremely premature,” he said. “China will probably do everything in its power to maintain a neutral position abroad.”

The author is Finance and Markets Editor at Reuters News. All opinions expressed here are his own.

(by Mike Dolan, Twitter: @reutersMikeD. Graphics by Andrew Galbraith and Marc Jones Editing by Catherine Evans)

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