Geopolitical tensions: a roadblock to the renminbi’s global ambitions?

The internationalization of the Renminbi (RMB) has been a central element of China’s economic strategy for over a decade. It is now the 4^th most used currency (below 5%) in the world for global payments, up from 35^th  in 2010 [https://www.bloomberg.com/news/articles/2024-04-18/yuan-usage-extends-global-climb-as-euro-share-slips-swift-says].

The Renminbi (RMB), China's official currency, is increasingly traded in global financial markets, reflecting China's growing economic influence. Major financial centers such as Hong Kong, London, and Singapore are key hubs for RMB trading, offering offshore RMB markets that facilitate international transactions and investments. In Hong Kong, the RMB is actively traded in both spot and forward markets, benefiting from the city's proximity to Mainland China and its role as a gateway for international investors. London has established itself as a leading RMB trading center in Europe, leveraging its position as a global financial hub to provide a range of RMB-denominated financial products and services. Singapore, with its strategic location and robust financial infrastructure, also plays a significant role in RMB trading, supporting the currency's integration into global trade and finance. Additionally, other financial centers like New York, Frankfurt, and Tokyo are seeing increased RMB trading volumes as part of the currency's internationalization strategy.

The Gulf Cooperation Council (GCC) countries are gradually diversifying away from the US dollar, enhancing trade with nations like China and India, according to a report by the Institute of International Finance (IIF). The GCC's US Treasury securities now constitute only 7% of their foreign assets. Despite the US's role as a key geopolitical partner, China has become the region's largest trade partner. GCC nations are increasingly signing bilateral trade agreements in non-dollar currencies, exemplified by the UAE's Comprehensive Economic Partnership Agreement with India and currency swap agreements with China. However, this shift remains limited due to GCC currencies being pegged to the dollar, ensuring regional financial stability. The IIF projects the GCC's gross foreign assets to reach $4.4 trillion in 2024, driven by current account surpluses. Nearly two-thirds of these assets are managed by sovereign wealth funds, with diverse investments in equities, bank deposits, foreign direct investment, US Treasuries, and bonds. Geographically, 65% of the investments are in North America and Europe, with the rest spread across Asia Pacific, MENA, Sub-Saharan Africa, and Latin America. [https://www.khaleejtimes.com/business/gcc-countries-slowly-diversifying-from-us-dollar-as-foreign-assets-near-dh16-15-trillion-mark-repor].

The Chinese government has made concerted efforts to elevate the RMB’s status to that of a global reserve currency, akin to the US dollar and the euro. However, the current geopolitical landscape poses significant challenges to this ambition.

Geopolitical tensions and economic sanctions

One of the primary factors impeding the RMB’s internationalization is the escalating geopolitical tension between China and major Western powers, particularly the United States. The trade war initiated during the Trump administration has evolved into a broader strategic rivalry encompassing technology, military, and human rights issues. The imposition of tariffs, export controls on Chinese technology firms, and sanctions against Chinese officials and entities have created an atmosphere of uncertainty and mistrust. These have been extended in 2024 [https://edition.cnn.com/2024/05/01/politics/us-sanctions-china-russia-ukraine-war/index.html]

These geopolitical frictions have led to a decoupling of growing economic ties, prompting businesses and investors to reassess their exposure to China. The result is a hesitancy to hold or transact in RMB, as companies seek to mitigate the risk of being caught in the crossfire of economic sanctions or sudden policy shifts between the US and China.

Financial market access and regulatory environment

Another significant hurdle is the regulatory environment and limited access to China’s financial markets. While China has made strides in opening its bond and equity markets to foreign investors, the pace and scope of these reforms remain cautious and tightly controlled. Concerns over capital controls, real estate systemic risks, repatriation of profits, and government intervention deter many potential investors.

Additionally, the opacity of China’s financial system and the lack of a fully convertible currency pose significant risks. International investors require a level of transparency and predictability that is often lacking in China’s regulatory framework. Until these structural issues are addressed, the RMB’s attractiveness as a global currency will remain limited. Foreign holdings of Chinese domestic bonds reached $570 billion in April 2024, which is a significant increase but still modest compared to the US Treasury market’s near $30 trillion.

The Renminbi (RMB), China's official currency, is primarily traded on the following markets which are segmented due to different regulations:

1. Onshore Market (CNY):This market refers to trading within mainland China and is tightly controlled by the Chinese government. The currency traded here is known as the Chinese Yuan Renminbi (CNY).
2. Offshore Market (CNH):This market allows the RMB to be traded outside of mainland China, offering more flexibility and fewer restrictions compared to the onshore market. The currency traded here is referred to as the Offshore Chinese Yuan (CNH). Major offshore trading centers include Hong Kong, London, Singapore, and New York.

Both markets operate under different regulatory environments, leading to potential differences in exchange rates between CNY and CNH and potentially the opportunity for regulatory arbitrage.

Global economic shifts and alliances

The geopolitical landscape is also marked by shifting alliances and economic blocs, which impact the RMB’s internationalization. The rise of regional trade agreements, such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and the Regional Comprehensive Economic Partnership (RCEP), creates new dynamics in global trade. While China is a key player in RCEP, its exclusion from CPTPP indicates the complex interplay of regional politics, as well as further economic decoupling.