The year of the yuan

This seems surprising since China is the biggest trading partner of both Thailand and Asean, but there have been restrictions on the use of the yuan, such as capital controls. Although these are being removed, there are still some barriers such as cost and liquidity. 

Other currencies such as the dollar, yen and euro have the advantage of free convertibility and high volume, so the funding rate is low. The yuan, on the other hand, has less flexibility in exchanging and the funding cost is relatively high while the recently developed offshore yuan market is also much less liquid than that of hard currencies. 

All this is about to change with the proliferation of settlement banks around the world. The most recent was in Thailand, where ICBC (Thai) was established as a yuan-clearing bank. 

This will increase the availability and flow of the yuan not only here but also in other Southeast Asian markets.

Once this happens, traders, both Chinese and their overseas counterparts will have an incentive to use the yuan rather than a third currency for settlement because they will be able to price their products more competitively with no conversion costs. 

It will also remove their exposure to foreign exchange risk, which would have been the case had a third currency been used. 

This will help lower overall transaction costs.

If Singapore’s experience is 

any guide, Thailand’s new yuan-clearing bank will have a big impact. 

In 2013, Singapore became the third country in the world to host a yuan-clearing bank and according to SWIFT, Singapore’s yuan payments soared by 375 per cent in the following year. 

At the inauguration of ICBC (Thai) as the new clearing bank for Thailand, the governor of the Bank of Thailand noted that a big increase in the use of the yuan in this country has already been seen. 

Trade settlements in yuan quadrupled from 2010-14 while its use for investment settlements rose from 1 per cent in 2010 to 14 per cent in the period. 

While this is still low, it is clear that the use of the yuan is rapidly accelerating and given the Chinese government’s commitment to the internationalisation of the renminbi, this trend will continue. 

The next big step in the internationalisation of the yuan will be its inclusion in the basket of reserve currencies that can be held by central banks. This is tipped to be announced by the International Monetary Fund this year. 

Another trend to watch is the increasing development of new financial products such as foreign exchange hedging tools, including forwards, swaps and options, and yuan-denominated bonds. These instruments will increase the depth of the market and provide greater funding flexibility for traders, further promoting the use of the Chinese currency.

With all that is happening, it seems that 2015 will be indeed the year of the yuan.