The road for the Chinese yuan to gain greater global acceptance will likely be long as capital account restrictions restrict the flexibility of the exchange rate, according to S&P Global Ratings.
Wider use of the yuan — also known as the renminbi — in foreign exchange markets, greater third-party use of the currency, greater capital account flexibility and a sustained current account deficit are the four checkpoints for the renminbi to gain further international acceptance, Ratings said in a report published July 10.
"China's policymakers appear in no hurry to remove capital account restrictions and thereby increase the flexibility of the exchange rate," said Vishrut Rana, Asia-Pacific economist at S&P Global Ratings. Therefore, the path for its currency to internationalization "remains gradual."
China started to internationalize its currency more than two decades ago through renminbi settlement on cross-border trade and the creation of yuan-denominated bond and offshore renminbi market. As the use of the renminbi has increased amid China's rising bilateral trade settlement and growing global influence, questions have been asked whether the currency of the world's second-largest economy has the potential to play a more significant role and even become the next US dollar.
Growing use
Renminbi cross-boarder settlement, as a proportion of global trade, rose to 3.2% in May 2023 from 2.1% at the beginning of the year, while China's share of global trade remained roughly the same, according to Ratings. Part of the reason is geopolitical as Russia increased payments in yuan, it said.
"Benefits for China include less need to accumulate foreign-currency reserves and lower international trade transaction costs," Rana said, while other economies enjoy lower cross-border transaction costs and diversify foreign-currency requirements.
But investors' need for flexible convertibility is not possible with capital controls in place, according to the Ratings report, and the policy choice regarding a free or controlled capital account involves a so-called impossible trinity — independent monetary policy, managed exchange rates and free capital flows.
China is keen to have monetary policy independence, the report said, but policymakers do not yet want a completely flexible exchange rate.
"China can increase the attractiveness of the renminbi for international investors by freeing up capital flows," the report said, adding, "but that would require exchange rate flexibility" which the People's Bank of China is reluctant to do.