(Yicai) July 19 — Since the initiation of cross-border trade settlement in Chinese yuan in 2009, the internationalization of the redback has achieved remarkable milestones. In May 2022, the IMF increased the yuan’s weight in the Special Drawing Rights basket to 12.28 percent from from 10.92 percent. The SWIFT report indicates that the yuan’s share in international trade settlements continued to rise this year, reaching 2.77 percent in June. However, recent data from the IMF’s Currency Composition of Official Foreign Exchange Reserves (COFER) shows that by the end of the first quarter of 2023, the yuan accounted for 2.58 percent of COFER, in contrast to 59.02 percent for the US dollar, 20.47 percent for the euro, 5.47 percent for the Japanese yen and 4.85 percent for the British pound. Academic research suggests that yuan internationalization should shift focus from the current account to the capital account to cultivate real demand for offshore yuan.
Hong Kong has been the primary base for offshore yuan development. By the end of 2021, yuan deposits and loans in major offshore markets were CNY1.54 trillion (USD206.3 billion) and CNY527.1 billion, respectively. Hong Kong held CNY926.8 billion (USD127.5 billion) in deposits and CNY163.6 billion in loans, accounting for 60 percent and 31 percent of the respective totals. Despite Hong Kong’s critical role in promoting the internationalization of the yuan, challenges remain, such as unstable liquidity and low loan demand. The offshore yuan capital pool from cross-border yuan settlement remains a key liquidity source for Hong Kong’s offshore yuan market. While the People’s Bank of China and the Hong Kong Monetary Authority have a standing currency swap agreement, the actual usage has historically been low. Furthermore, the limited range of yuan-denominated financial products in Hong Kong makes it difficult to attract overseas institutional investors. Hong Kong’s position as a global offshore financial center means the redback must compete with other international currencies, especially during periods of dollar appreciation.
In the process of yuan internationalization, controlling macro monetary policy and ensuring domestic financial market stability are critical. Since November 2018, the People’s Bank of China has regularly issued offshore yuan central bank bills in Hong Kong, strengthening expectation management. However, the policy tools to regulate offshore yuan liquidity remain limited. Between 2010 and 2015, the yuan’s unilateral appreciation and the large interest rate differential between China and the US spurred cross-border arbitrage, which often disguised itself as yuan cross-border trade or investment settlement. This led to a bubble in yuan internationalization. After the Aug. 11 exchange reform in 2016-2017, the yuan’s depreciation and the narrowing interest rate differential between China and the US halted yuan internationalization, causing Hong Kong’s offshore yuan capital pool to shrink. Thus, to cultivate real demand for offshore yuan, the impacts of speculative demand and potential bubbles on the domestic financial market much be taken into consideration.
Given the limited space for developing overseas yuan financial centers, building Shanghai into a domestic offshore yuan financial center is crucial for consolidating and steadily advancing yuan internationalization.
The construction of Shanghai as an international financial center is a significant national strategy proposed by the Central Committee of the Chinese Communist Party and the State Council. In 1992, the 14th National Congress of the Communist Party of China introduced the strategy, marking the inception of Shanghai International Financial Center Construction Version 1.0. The 2009 “Opinions of the State Council on Promoting Shanghai to Accelerate the Development of Modern Service Industry and Advanced Manufacturing Industry to Build an International Financial Center and an International Shipping Center” (Document 19) laid the framework for Shanghai International Financial Center Version 2.0. By 2020, the goals set in Document No. 19 were largely achieved. The “Opinions on Further Accelerating the Construction of Shanghai International Financial Center and Financial Support for the Integrated Development of the Yangtze River Delta” (2020) and the “Fourteenth National Economic and Social Development of Shanghai” Five-Year Plan (2020) mark the entry into the 3.0 era.
Shanghai’s “14th Five-Year Plan” outlines six specific goals for 2021-2025: establishing a global asset management center, a financial technology center, an international green financial hub, a cross-border yuan center and becoming a highland for international financial talent and financial business environment. Based on these goals, developing an offshore yuan financial center in Shanghai will be crucial for yuan internationalization. The focus should be on “one center” (i.e. cultivating real demand for offshore yuan) and “walking on two legs” (i.e. enhancing service for the real economy and improving financial openness).
First, enrich the supply of financial products and create cross-border two-way investment channels. As early as 2015, the State Council issued the “Plan to Further Promote Financial Opening and Innovation in the China (Shanghai) Pilot Free Trade Zone and Accelerate the Shanghai International Financial Center,” which pointed out that it is necessary to study the launch of overseas investment pilots for qualified domestic individual investors. Individuals who meet the necessary conditions can be permitted to carry out overseas industrial investment, real estate investment and financial investment. In addition, it is necessary to continuously innovate internationally oriented yuan financial products and broaden the channels for the return of yuan investment.
On the one hand, high-quality yuan assets are a major prerequisite to encourage non-residents to use the redback. On the other hand, China’s economic development has also entered a stage where assets and resources need to be allocated based on a global perspective. Therefore, expanding financial openness and accelerating financial innovation are common aspirations of residents and non-residents. At present, the Shanghai Free Trade Zone adopts the principle of “liberalizing the first line, efficient control of the second line, and free circulation within the zone” to establish a regulatory model in the free trade zone corresponding to the development needs of international trade and other businesses. Under this regulatory model, relevant departments can carry out innovation in the bond market, repo market, derivatives market and insurance market, enrich the supply of offshore yuan financial products and create a cross-border two-way investment channel.
On June 8, Li Yunze, director of the State Financial Supervision and Administration Bureau, and Shanghai Mayor Gong Zheng announced the launch of the reinsurance International Board during the Lujiazui Forum. Immediately, the “Implementation Rules on Accelerating the Construction of Shanghai International Reinsurance Center” were released, which means that the transformation and upgrading of the reinsurance market from “one-way openness” to “two-way openness” has become embedded in the construction of Shanghai as an international financial center and the construction of a domestic offshore yuan financial center.
The second is to create financial assets denominated in yuan to attract overseas institutional investors. To enhance the attractiveness of yuan-denominated financial assets and expand the cross-border use of the yuan, more breakthroughs need to be achieved in the innovation of yuan-denominated assets. Firstly, China is a major importer and consumer of global commodities, and it is feasible to launch yuan-denominated commodity futures. Secondly, on July 24, the Central Committee of the CCP pointed out that it is necessary to activate the capital market and boost investor confidence. The proportion of foreign investment in China’s stock and bond markets is still very low, and there is a lot of room for improvement. Shanghai should give full play to its advantageous position as a financial center and promote the concentration of financial resources in Shanghai. For example, it can encourage qualified multinational companies and multilateral financial institutions to issue panda bonds on the Shanghai interbank and stock exchanges, and gradually expand futures trading of specific varieties. It can continue to open up to the outside world, moderately broaden the investment scope of QFII and RQFII, and further expand the scope of pilot projects for foreign investment equity and investment enterprises.
The third is to improve resource allocation capabilities and promote financial empowerment of technological innovation. Shanghai is a financial center, a science and technology innovation center and an industrial highland. The purpose of financial development is not finance itself, but to better serve the real economy. In 2017, the Shanghai Municipal Government issued “Several Opinions on Innovation-Driven Development to Consolidate the Energy Level of the Real Economy” (referred to as the “50 Real Economy Points”). Shanghai actively aligned with the national strategy and made every effort to build three leading industries, namely integrated circuits, artificial intelligence, biomedicine, and create six key industrial clusters.
Due to their own characteristics, emerging industries require diversified financing strategies, and traditional bank credit cannot adequately meet their financing needs. Therefore, it is urgent to accelerate the construction of a new industrial system and create high-end manufacturing growth to improve the allocation of resources and financial service efficiency of Shanghai International Financial Center. Shanghai should seize new opportunities from the deep integration of technology, industry and finance, improve direct financing (equity + debt), indirect financing and other financial services, explore financial risk sharing mechanisms for emerging science and technology enterprises, and activate global demand for yuan investment and financing. It should also enhance the role of the redback in the global investment and financing system while at the same time building a global science and technology innovation and financial center.
The fourth is to establish a sound and robust regulatory framework to coordinate safe development. In the free trade zone where capital accounts are basically freely convertible and various components of the financial market system are more closely linked, attention must be paid to systemic risk prevention and macro-prudential supervision must be strengthened. Since the reform of financial factors is relatively thorough in the free trade zone, the traditional regulatory framework of separate industries and departments has become outdated. It may be feasible to establish specialized free trade zone financial regulatory agencies to strengthen the supervision of cross-market and cross-sector financial institutions and products.
In the process, we need to pay attention to the negative impact of the offshore market on the onshore market. Under the current regulatory framework of “liberation on the first line and control on the second line,” the free trade account of the free trade zone is different from other banks in the country, including in the zone. The flow of funds between settlement accounts is managed according to the principle of “limited penetration and strict management.” The degree of “limited penetration” must be accurately grasped, and onshore and offshore businesses must be strictly distinguished. Only in this way can the transmission of risks from the offshore financial market to the onshore financial market be prevented.
(Li Jianjun is a macroeconomic expert who has been involved in investment management and capital market transactions in state-owned banks, state-owned financial holding groups and listed companies for many years.)
