Pakistan Agriculture News

Pricing oil in yuan may be next move in China’s currency ambitions

AN attempt to wean the world off US-dollar priced oil would mark another milestone for the yuan.

Much has been written about China’s emergence as a major exporter of capital that would inevitably increase its companies’ ownership of physical and intellectual assets in Europe and the United States.

However, on one front, there is a conspicuous lack of discussion — the internationalisation of the Chinese currency. That would seem odd considering the great efforts made by China to turn the yuan into a reserve currency by becoming the fifth currency in the basket that formed the International Monetary Fund’s (IMF) Special Drawing Right.

Not to mention the growing role which Chinese equities now play in international investors’ portfolios. Stock index provider MSCI announced in June that it would add 222 China A-shares, traded on mainland bourses, to its benchmark emerging markets index from next year.

Yet, as The Economist magazine recently noted, the yuan’s international reach appeared to have faltered in the past two years.

While it has regained its rank as the world’s fifth most active currency for international settlements this year, its monthly market share in international payments has slipped to 1.9 per cent in August from 2.8pc two years ago.

The Economist also noted that the use of the yuan to raise funds in the global bond markets over this two-year period has also fallen by half, as companies have chosen to raise funds within China.

What is interesting is that in Hong Kong, the largest offshore yuan market, yuan deposits have plunged by 47pc from their peak in December 2014.

As for the role of the yuan as a reserve currency, just 1.1pc of the foreign exchange reserves held by the world’s governments are in yuan compared with 64pc for the US dollar.

Still, there may be a simple explanation for what happened. Until August 2015, the Chinese currency had tracked the US dollar for as long as anyone could remember. But in that month, as a prelude to getting the yuan named as a reserve currency by the IMF, China decided to ditch its soft-peg to the greenback.

As the move took place amid a stock market crash in Shanghai and a drop in China’s monthly exports, the subsequent modest decline in the yuan was misinterpreted that the Chinese economy might be in worse shape than previously envisaged.

But since January, China’s foreign reserves have been growing again, while gross domestic product growth in the first half accelerated to 6.9pc from last year’s 6.7pc.

As China’s central bank noted recently, the scope of the yuan “will be further expanded in 2017 and usage channels will be further widened”.

Since a 1974 agreement between then US President Richard Nixon and Saudi Arabia’s King Faisal, Saudi Arabia has accepted payments for nearly all of its oil exports in greenbacks.

As a result, since virtually all global oil transactions are settled in US dollars, when a country does not have a surplus of US dollars, it must create a strategy to obtain them in order to buy oil. This forced many countries — especially those from Asia — to develop an export-led strategy with the US in order to exchange their goods and services for greenbacks they would need to buy oil in the global market.

It also leads them to build huge mountains of foreign reserves in US dollars and enables the US to keep its interest rates low because of the enormous demand for its currency.

But China is now the world’s biggest importer of oil, with data from Opec showing that its total crude oil demand rose 6pc in July to 11.67 million barrels a day from a year earlier.

It would not be surprising if it tries to price its oil purchases in yuan rather than the US dollar.

The plan is to price oil in yuan using a gold-backed futures contract in Shanghai that will be able to compete with more established benchmarks such as West Texas Intermediate or Brent crude, both of which are US dollar-based.

Whether China succeeds in weaning oil majors and big-time traders off US dollar-priced oil remains to be seen — but it will mark another milestone in the country’s ambitions to turn the yuan into a currency prized by the international financial markets.

Whether this new contract takes off remains to be seen, but it marks another chapter in China’s ambitions to internationalise its currency.

Source Dawn