China has made great progress opening up its financial markets to the world but still needs to speed up the process. Beijing wants broader acceptance of the renminbi as an international medium of exchange and for it to become a more popular reserve currency, but its share of the global official reserves market still only stands at a meagre 2.7 per cent.
The challenge is how to break into the big time and take on the euro’s share at 20 per cent of the market, let alone challenge the US dollar’s dominance with a 58 per cent market share. Beijing still has some way to go to fully internationalise its currency, opening up its markets to all-comers and building global confidence in China as a safe enclave for investors.
The dilemma is opening up China’s financial markets without exposing the renminbi to too much implicit risk in the process.
Without a doubt, China’s sovereign credit standing and foreign earnings capability are extremely strong, underpinned by a record trade surplus in 2022, surging by about 30 per cent over the year to US$877.6 billion, the highest since records began in 1950.
Yet, in the past 10 years, China’s official currency reserves have fallen from a peak of about US$4 trillion in 2014 down to just over US$3 trillion at present.
Beijing’s understandable concern is that by opening up its capital markets at too rapid a pace, it might spark an outflow of hot money, adding a further drain on reserves in the process. It might be the price of increased internationalisation for the currency, so the challenge is finding an appropriate balance that promotes financial stability.
This means having the right kind of economic and financial fundamentals which draw in foreign investors, while encouraging domestic savers to keep their money invested in home markets.
China’s economic fundamentals are certainly without parallel. China boasts the world’s largest holdings of foreign exchange reserves, has the world’s biggest trade surplus and is the foremost global exporter of goods and services.
At the same time, it has the best growth performance among the major industrial countries. Economic growth at 4.5 per cent in the first quarter of 2023 beats anything the G7 nations can offer by a wide margin.
The fact that China’s inflation rate is currently so low – at 0.7 per cent in March, year on year – underlines that there is still plenty of scope for Beijing to get close to this year’s GDP growth target of around 5 per cent with a further easing in monetary policy, without risking domestic overheating pressures.
Another cut in interest rates should provide a relative boost for China’s equity and bond markets at a time when other major nations are weighing up more interest rate rises to combat inflation.
China’s currency popularity is moving up the ranks, with the renminbi rated the fifth most actively traded, according to the Bank for International Settlements, behind the US dollar, euro, Japanese yen and UK pound.
It still has a long way to go to catch up to the dollar, thanks to the latter’s record as a universal means of exchange, its safe haven appeal and long-held role as the anchor currency for so much international trade and finance.
With the renminbi’s popularity rising, the attractions of investing in China will only grow as Beijing continues to grant easier access to its domestic markets. China’s financial markets offer good depth and breadth, with high liquidity and scope for investor diversification. Improvements to market transparency, supervision and regulation are key to winning investor trust, not only at home but abroad too.
Maintaining market stability and reducing volatility will be critical for investor confidence, given that global markets have been subject to so much turmoil in recent years. It will be a major achievement if, in future, investors can consider China as a possible go-to market in times of stress, on a par with the US dollar on currency terms or German government bonds for fixed-income needs. It’s a hearts and minds exercise and Beijing has much to play for. With the right policies and sound economic fundamentals, there’s no reason the US dollar’s global dominance can’t be challenged in the future. It’s just a matter of time.