China – CNY’s Role in Global Trade

When discussing international trade, one currency cannot be overlooked: the Chinese Yuan (CNY), also known as the renminbi (RMB). Over the last twenty years, China has emerged as the world's manufacturing hub and the second-largest economy. Accompanying that growth is the contemplation of whether the currency of a key economic player should remain a secondary currency used in international trade.

Its expanding role is giving us answers. The CNY has transformed from a currency tightly regulated in domestic use to one that is increasingly being used outside of China. The Yuan is a representation of China's growing prominence in the global economy. But how does it influence trade flows and foreign exchange markets today? Let's take a look.

China's Economic Power and Trade Implications

China is the world's largest merchandise exporter, exporting a wide range of products, including electronics, machinery, textiles, and chemicals. Its enormous production capacity, low-cost alternatives, and global supply chain networks mean that the Yuan is well connected to trade transactions around the world.

With trade volumes climbing, China made a logical push for increased use of its currency in international settlement (not just for the sake of it but to create less dependence on the US dollar).

From Domestic Currency to International Currency

For most of the past few decades, the Yuan was primarily a domestic currency. Yan controls were strict, and the use of the Yuan internationally was limited; most trade worldwide was transacted in dollars. But as China opened its economy and its network of cross-border partnerships (or commerce) expanded, CNY for cross-border transactions was promoted.

The launch of the offshore yuan market in Hong Kong in 2010 marked a significant shift. It has established a marketplace that allows businesses and investors to trade in CNY more fluidly, setting a future milestone for expanded global use.

Yuan Internationalisation Strategy

The Chinese government is actively working to increase the use of the Yuan through a combination of policies.

• Bilateral trade agreements, promoting partners to settle deals in CNY

• Currency swap lines, where the People's Bank of China (PBoC) has signed swap agreements with dozens of central banks to provide liquidity in Yuan

• Financial hubs, where Hong Kong, London, and Singapore become major centres for Yuan trading

This strategy conveys China's long-term ambition to decrease its reliance on the US dollar and increase its own role in global finance.

The Yuan and Belt and Road Initiative

Similar to the earlier summary I provided, the Belt and Road Initiative (BRI), China's massive infrastructure and investment project, has increased the use of the CNY. If countries receive Chinese funds or invest in China's BRI, those countries will often settle a portion of their trade in CNY. This diminishes reliance on other trade partners, while also expanding the US dollar footprint in emerging markets.

CNY in Commodity Trade

China is the world's largest consumer of commodities, including oil, iron ore, and copper. China has also been driving the price and settlement of some of these commodities in CNY. For instance, the crude oil futures contract in Shanghai allowed oil-exporting nations to accept payments in CNY rather than dollars. (China provides legitimacy and practicality to the role of its currency in the global financial structure by associating the Yuan with the flows of the international commodities market.)

The Yuan vs. the US Dollar

While the Yuan is making slow progress, the dollar remains the most widely used currency in international trade.

• The Dollar is Dominant: Over 80% of global trade is still billed in USD.

• Gaining Ground with the Yuan: The CNY is now among the top five currencies used for global payments, which indicates a steady increase.

While the presence of the Yuan does not necessarily suggest a direct removal of the dollar, it does indicate diversification in global finance, particularly from nations currently seeking alternative options.

Central Bank Reserves and the SDR of the IMF

In 2016, the Yuan was included in the basket of Special Drawing Rights (SDR) currencies of the International Monetary Fund (IMF) alongside the USD, EUR, JPY and GBP. Joining the ranks of the four other currencies was an essential milestone in the CNY's recognition as a global reserve currency.

The number of central banks holding some yuan in their foreign exchange reserves has also increased, an indication of growing trust in China's influence and stability.

Challenges of the Yuan

Despite its achievements, CNY continues to face challenges:

• Capital controls: China has limitations preventing excessive outflows, which curb the full convertibility of the currency.

• Lack of Transparency: Investors across the world identify transparency as an issue in China's financial system.• Geopolitical tensions: Trade disputes, sanctions, and global politics shape confidence in the CNY. The result of these challenges is that the pathway for the Yuan to evolve into a thoroughly dominant currency will be gradual, rather than immediate.

Case Studies of Yuan in Action

• China-Russia Trade: As tensions with the West have intensified, Russia has increased energy trade with China, settled in Yuan.

• Africa and Asia: Many developing economies trading with China are starting to use CNY to settle transactions directly, instead of selling in USD.

• Commodity Pricing: Increasingly, commodity contracts priced and settled in Yuan are giving commodity exporters a method of trading that does not rely on using dollars.

These cases demonstrate how CNY is being established for trade in various regions and sectors of global trade.

What It Means for Forex Traders

For forex traders, the CNY's increased role creates opportunities and challenges.

1. Worry about China's policies. Currency is often moved by news announcements from the government and decisions from the PBoC. 

2. Keep track of global adoption. More trade deals settled in Yuan can create momentum in the market.

3. Pay attention to U.S.-China policy relations. Politics loosely translates into currency volatility.

4. Look at commodities. China is a major buyer of commodities, and therefore, demand can influence the Yuan's performance.

To summarise, the Yuan is becoming increasingly relevant, but it remains heavily policy-driven and therefore retains its significance in relation to major currencies.

Conclusion

The rise of the Chinese Yuan, or CNY, in global commerce is arguably one of the more significant events in 21st-century global finance. CNY, which was not more than a decade ago, used only for domestic purposes, now represents an economic powerhouse with political and strategic implications.

While the US dollar remains the dominant currency in global commerce, the gradual strengthening of the CNY signals a significant shift in how trade operates and how countries manage their reserves. For traders, the government, and businesses, it is universally relevant to understand the footprint and implications of CNY on the global economy.

As China continues to open its financial markets gradually and is a significant trading partner, the story of CNY as a currency for trade is not yet complete—and will only deepen in global trade, commerce, and finance in the near future.