Long-term rise of yuan intact despite challenges

Despite near-term challenges over growth and geopolitics, the RMB is likely to increase its share in global forex reserves over the long-term.

When the renminbi was included in the special drawing rights basket in 2015, expectations for a rapid rise of the Chinese currency — also known as the yuan — in the global financial architecture were high. In fact, over the following years, the RMB's share within global foreign exchange reserves more than doubled to 2.8 percent in 2021, according to IMF's Currency Composition of Official Foreign Exchange Reserves data.

The widespread assumption at that time was that the RMB would eventually challenge the dominant role of the US dollar. However, the pace of growth of the RMB's share of forex reserves has been hindered by several factors in recent years. According to the IMF, its share fell slightly to around 2.3 percent by the end of 2023.

UBS Asset Management carries out an annual survey of central bankers ahead of its Reserve Management Seminar in June. In its 2024 survey, the RMB's average long-term target allocation among reserve managers stood at 5 percent, a slight drop from 5.2 percent in the 2023 survey. However, looking at the year ahead, central banks are planning to further add to their RMB positions. Overall, 70 percent of survey respondents answered that they had already invested, or were considering investing, in the Chinese currency.

The pause in the march of the RMB to global reserve currency status is due to multiple factors.

First of all, the rise in US interest rates that began in 2022 to fight inflation has moved the interest rate differential in favor of the greenback, leading to reserve managers taking advantage of higher yields in the US Treasury market.

Next, international investor sentiment toward China, including reserve managers, is currently weak due to the country's ongoing economic challenges.

Finally, geopolitical tensions and the risk of sanctions have somewhat dented the appetite of central banks for onshore yuan assets. Following the start of the conflict in Ukraine, the US and its allies targeted reserves held by the central bank of Russia, raising concerns among central banks about sanction risks stemming from forex reserves, and whether they can continue to be perceived as "safe" assets. The increase in direct and indirect sanction risks has undoubtedly impacted demand for the Chinese currency among reserve managers.

What is the outlook for the RMB and can it resume its growth in global reserves?

The US-China interest rate differential is expected to fall going forward as the Fed starts easing interest rates. Should the US economy slow down significantly or even fall into recession, the interest rate differential could disappear. This would make RMB fixed income assets more attractive going forward.

The challenges faced by the Chinese real estate sector are on track to eventually get resolved as the Chinese government continues implementing targeted policy measures. This may also have a positive impact on household consumption and growth.

What about geopolitics? According to the latest UBS RMS survey, when asked which reserve currencies are most likely to benefit from macroeconomic and geopolitical shifts over the next five years, the greenback and the yuan were the two currencies most often mentioned, followed by the yen and the euro. When asked specifically about the impact of US-China tensions on the internationalization of the renminbi, 47 percent of respondents said that it had no impact, 39 percent believed it had slowed it down and 14 percent thought it has accelerated it.

Demand for diversification of reserves away from the US dollar remains strong globally, driven by geopolitical, economic and financial dynamics. So far, this process has been slow as the US economy and its currency have outperformed expectations. We believe the dollar is and will remain for the foreseeable future the main store of value for global investors, including reserve managers. However, currency diversification is set to continue in the future as the world gradually moves toward a multipolar system. The RMB looks set to continue its steady rise in global forex reserves, in particular if it is supported by an improvement in the Chinese economy, the ongoing rise in the use of yuan in cross-border payments and the more widespread use of the digital RMB.

The writer is head of strategy for official institutions, UBS Asset Management.

The views do not necessarily reflect those of China Daily.