Inclusion of yuan in SDR is a reminder for businesses

The decision has been a long time coming, and has in effect granted the status of a reserve currency to the yuan.

At first glance, it looks like the kind of development that should be of primary interest to central bankers, who will be thinking about how to reallocate their reserves to match more closely the basket of currencies that make up the SDR. 

With a little reflection, however, it should be clear that the move by the IMF is a reminder to companies across the world that the yuan needs to be part of their strategy.

The reasoning is as follows. The yuan’s newfound status as a reserve asset is, over the medium term, going to boost demand for the currency among central banks. A recent Bloomberg poll of reserve managers gave a median prediction of 10 per cent of global foreign-exchange reserves being held in the Chinese currency by 2025. 

To put this into perspective, there is US$7.8 trillion worth of reserves globally outside of China. So if such a diversification were to take place today, it would require nearly $800 billion going into yuan-denominated assets.

As countries hold more of their wealth in the yuan, it gives a powerful sign to businesses that the currency is a viable store of value. The result will be an uptick in companies using the currency to settle international trade.

China’s capital outflows are also growing rapidly, as local investors diversify into foreign assets. Outbound investment by businesses and individuals is expected to generate $1.5 trillion worth of outflows by 2020. 

The yuan will be stuck in the middle of a supply-and-demand tug-of-war that is set to increase the level of two-way volatility in its exchange rate. 

It will be a sharp turnaround from the situation just a few years ago, when the Chinese currency was considered by many to be a one-way bet on appreciation.

Any company doing business with China should take note of this upcoming chain of events, as movements in the yuan are set to become a consideration that cannot be ignored. Different companies however, will have different areas of focus. 

A manufacturer sourcing parts from China may well be mostly focused on the exchange rate, which could influence the cost of some of its components. 

A foreign firm investing in China while directly trading with local customers will need a more advanced currency strategy that takes into account not only the value of the yuan, but also the liquidity situation to ensure that it can get hold of enough cash to meet its obligations.

With volatility in the yuan increasing, the costs of eschewing currency considerations could be considerable – even for companies with little direct exposure to China. 

As the world’s second-largest economy, it has a huge influence on everything from the health of emerging markets to the price of commodities. A significant shift in the outlook for the yuan could have a substantial impact on financial markets, trade flows and even international relations.

We got a taste of the yuan’s importance during the summer, when the People’s Bank of China increased the currency’s flexibility via a one-off adjustment that led to a sharp, but short-lived, depreciation. 

Financial markets went into a tailspin, and the media were quick to announce that China had fired its first shot in a global currency war. 

The panic quickly died down, and although the central bank’s move was a shock to some, for those paying close attention to the yuan, it was simply the latest step in China’s long-term goal to introduce more market forces into the valuation of its currency.

There’s no one-size-fits-all yuan strategy for all companies. Every business needs to find an approach that fits its circumstances. 

But what’s clear is that despite encouraging signs that companies want to do more business with China, many firms are missing out on the chance to get ahead of their rivals by including the yuan in their business planning. 

According a survey by HSBC this year, only 22 per cent of businesses are using the yuan to settle transactions.

The trend, though, is clear – the yuan is on track to enter the top tier of global currencies, and the IMF’s SDR decision is only the latest reminder. The imperative for businesses the world over it is to make the currency a key part of their foreign exchange considerations. Those failing to do so could find themselves playing catch-up with their competitors.

 

Vina Cheung is head of RMB (renminbi) internationalisation at HSBC.