The limits of currency diplomacy

By Edward Chui, Hong Kong director

Since the end of 2022, President Xi Jinping’s accelerated diplomatic efforts have led to high profile meetings with heads of state from Singapore, Malaysia, France, the European Commission, Spain and most recently, Brazil. Mr. Xi has also affirmed his rapport with Russian President Putin in Moscow and brokered a resumption of diplomatic ties between Saudi Arabia and Iran in what the EIU noted last year was a purposeful attempt to “make up for lost time” during the pandemic by attempting to foster a more benign international environment for itself, as domestic economic and political risks grow. President Xi’s ‘charm offensive’ looks to be in response to US attempts at containment as he continues to encourage Asian leaders especially to band together and “firmly oppose bullying, decoupling or severing industrial and supply chains”.

Alongside this spate of commercial agreements and establishment of stronger trade ties is China’s concerted effort to promote the use of China’s renminbi as a potential alternative to the US dollar as a global reserve currency by increasing its use in international trade and investment. Brazil’s Lula recently called upon BRIC nations to end dollar trade dominance while simultaneously attacking the supremacy of the US dollar in international trade, explicitly asking: ‘why can’t we do trade based on our own currencies?’ The discussion, which seems to come up every few years, stems from an increase in yuan denominated assets as more investors seek exposure to China.

While there remain several challenges that need to be overcome before the yuan can become a true alternative to the US dollar, it does show China’s influence with its trading partners but also a recognition that the sanctions inflicted on Russia by America and its allies underscores China’s dependence on the dollar and its own vulnerability to the US controlled financial system, a topic addressed in February by Professor Michael Sung at our EICN HK event, “Central Bank Digital Currencies (CBDCs) in 2023 and will the e-CNY help China dodge the dollar?”

Realistically, the hegemony of the US dollar dominates global trade settlement and invoicing while the renminbi accounts for only 2.2 percent of global payments for all types of transactions. Most talk of expanding renminbi usage for trade is among developing countries likely due to their continued reliance on China for exports. For yuan internationalisation and adoption to succeed, a greater proportion of renminbi-denominated trade needs to be settled between countries that do not involve China. The lack of transparency and openness in China’s financial markets and the Chinese government’s tight control over its currency are other obstacles that will limit the yuan’s use in international transactions and investment.

So while President Xi continues to meet with world leaders and attempts to reshape the global power narrative, the issue of having the yuan displace the US dollar as a global reserve currency is more rhetoric than reality even as China establishes growing influence and credibility in trade settlements with its growing list of trading partners.