The rise of the Chinese economy (and its geopolitical assertiveness) seems to make the CNY a natural challenger to the dominant Western USD-centred financial system. China’s rapid rise as a leading trading partner could rival the existing currency regime, much like the USD challenged the status of the GBP after World War II. However, as history tells us, economic influence is definitely not the only factor at play. Based on existing academic research, we find that the following five factors help summarise the determinants of the global role of a currency:
- Economic size of the currency’s issuing country
- Credibility and confidence in the currency as a storage of value
- Internationalisation of the currency, namely its usage in cross-border trade and financial transactions
- Convertibility of the currency or the level of restrictions on capital flows
- Reserve currency status, that is, whether other central banks are holding the currency (as protection against crises)
Based on these five concepts, we built a country-specific Global Currency Index for the currencies of the major developed economies, that is, the USD, EUR, JPY and GBP (sometimes labelled the “Big Four”) as well as the CNY. Our results show that the USD remains by far the most dominant currency, while the JPY, the GBP and the CNY have been at similar levels in the past years (and the EUR in-between) (Exhibit 1).
Exhibit 1: Global Currency Index
Since Q1 2009, our Global Currency Index for the CNY has nearly doubled, mostly at the expense of the EUR, and to a smaller extent the JPY and the GBP (see Exhibit 2). The CNY’s rise is mostly explained by the economic size and internationalisation sub-components. If we very simplistically extend the trends of the past five years, we find that the CNY’s global role could be similar to that of the EUR by 2027, although with respective influences likely in different geographic areas. This is of course dependent on multiple factors both at home and abroad, and getting on par with the USD is likely to take much longer, if it is possible at all.
Exhibit 2: Global Currency Index (change between Q2 2022 and Q1 2009, with contributions by sub-component)
Trends and initiatives that could accelerate the move towards a polarised global financial system
While the global financial system could gradually become polarised, given rising tensions between the West, Russia and China, third countries will not necessarily have to make hard choices between two antagonistic poles. Three factors will determine the path ahead: geopolitics, technology and financial reforms.
Large emerging market economies – bonded by a common desire of reshaping the current status quo? Such countries have made progress in many economic aspects in the past decades, but there is still one big item which lags the rest: their role in the financial world. Besides the mismatch between weights in the real and financial economies, there is the underlying sentiment of unfairness, where emerging markets are participants/users of a system controlled by others (basically the Western USD-cantered system) and exposed to financial shockwaves coming from the US.
In theory, reinforcing the relationship between large emerging market countries could gradually change their roles in the financial world from borrowers to creditors, and potentially establish new institutions and channels independent of the “West”. Nonetheless, the fact that large emerging market countries are located in multiple regions is at the same time a strength and a weakness, as on the one hand it allows for a common emerging markets front, but on the other it needs to address multiple and sometimes conflicting interests.
At the regional level, the Shanghai Cooperation Organization (SCO) is probably the most important in terms of population, size and economic relevance. A Sino-Russo initiative, it comprises most of the Asian continent and is trying to reach the Gulf countries, which would favour a polarised world, and which could have implications for part of the oil pricing. Among other goals, it emphasises the need to boost the use of mutual national currency settlement as a way to reduce dependence on the dollar. Note that research finds that as of the end of 2021, Russia held nearly a third of the world’s CNY reserves.
A different system needs institutions that support it. What matters more is whether successful financial institutions can carry out the undoubtedly crucial role of finance in supporting the global role of a currency. As much as the struggle for a bigger role stresses the problems of the current system, it would be unfair not to acknowledge the positive aspects that the Bretton Woods system brought, which have allowed the globalisation of finance after World War II. Along this line, China launched the Asian Infrastructure Investment Bank (AIIB) in 2016, a multilateral bank that aims to rival the World Bank, and whose main purpose is to foster the long-term development of the Asian continent via infrastructure investments. Although the increasing creditor role of China is reflected in other alternatives as well (such as the Belt and Road Initiative), the creation of China-led institutions is a step further in the attempt to create a new financial pole. For the time being, external efforts have concentrated in neighbouring countries and Africa, a region less integrated in global financial networks (see Exhibit 3).
Exhibit 3: Share of China (as country of counterpart) in external debt of emerging markets and developing economies
Another institution crucial in promoting the CNY internationally is the People’s Bank of China or PBOC. History has shown that a transparent and credible central bank needs to stand behind a currency with a global role. This contributes to sound public policies at home, as well as potential cross-border measures to ensure sufficient liquidity of the currency globally. The PBOC seems to be aware of this, and it has adopted some of the tools that are in the Fed toolbox. One of them is bilateral currency swap lines, which are crucial in times such as today (currency depreciations, increasing balance of payment risks in many emerging markets) to provide exchange rate stability and avoid liquidity-drain events. As shown in Exhibit 4, China has in the past created a network of bilateral swap lines that has focused on Asia and the countries with which it has stronger trade linkages. The aim has been to increase the usage of the CNY in a not fully-convertible and fully-open capital account framework, and shore-up its international role as lender of last resort, measures consistent with its aim of becoming an alternative pole in the financial world.
Exhibit 4: Number of bilateral swap lines
An EM-based SDR could be a game-changer for reserves composition. But is it vision or delusion? Within large emerging market currencies, the CNY has been part of the IMF’s Special Drawing Rights (SDR) since 2016. But despite an increase in August 2022, its weight still does not fully reflect its role in the global economy. As a result, voices claiming for a different SDR—composed of the major emerging market currencies—have grown. EM-SDRs or a different weighting in the current IMF-SDRs would therefore have important consequences and would translate into a major shift of monetary power to China, as well as major responsibilities that could spark a loss of confidence if poorly managed. In this regard, China’s offshore market for the CNY is already a step towards improving convertibility and shoring-up international trust in the currency. In the hypothetical case of an EM-SDR, the weights of the CNY would be clearly dominant, as it accounts for nearly 40% of emerging market exports, and it is the only currency in this group that has significant usage in international transactions. This could complicate the existing frictions among emerging market countries. In terms of adoption, it is also not clear how an EM-SDR would work, although its initial users would in principle be countries already aligned with a CNY-cantered pole.
One (CNY) can’t beat someone (USD) at their own game, but technological changes change the rules. China and other vocal critics of the current system realised that developing technology is also needed, in addition to having the financial muscle. The PBOC’s development of CIPS (Cross-border Inter-bank Payment System)—which allows clearing and settlement in CNY—has been followed by the e-CNY, China’s central bank digital currency (CBDC). Although in a less advanced stage, the mBridge project—with China leading, under the auspices of the BIS—aims to connect multiple CBDCs, which would eliminate the potential problems that cross-border payments could pose against the use of CBDCs. At scale, this represents a major step not only towards decoupling from the USD financial system but to establish a new one.
The path for the CNY to reach financial “co-hegemony” with the USD is definitely not straightforward
Geopolitical headwinds. Many of the largest emerging countries have closer ties with the US than with the “instigators” of a future polarised financial system. The border disputes between India and China, the reluctance of some Southeast Asian countries to embrace a stronger China and the still dominant position of the US in the American (and Asian) continent could hinder the progress of the CNY. As of today, while many countries share the desire for reducing their vulnerability to the USD, a pragmatic solution involving multiple emerging markets seems difficult. While the inclusion of the CNY in the SDR basket opened the door to the coexistence within the same system, recent developments (in particular the freezing of Russia’s reserves) have proven the importance of being in control of the underlying financial infrastructure, and therefore have made a polarised financial world more likely.
Domestic issues could hinder the international progress of the CNY as rival to the USD. While progress in China’s reforms towards capital account liberalisation had been fast in the 2000s and early 2010s, there have been some roadblocks. Stronger capital controls were put in place in 2015-2016 to contain the strong depreciation of the CNY and manage the Mundell-Flemming trilemma, and less emphasis has been given to the Belt and Road Initiative in recent years after some bold investments abroad did not always prove sustainable. Furthermore, sweeping regulations in the technology sector in 2021 have also raised concerns regarding political risks. While Chinese leaders likely still aim to increase the global role of the CNY, the increasing number of domestic issues in recent years could risk slowing down the pace of further reforms and consequently the opening of the Chinese financial system.
Françoise joined Allianz Trade in 2019 as a senior economist for Asia-Pacific. Prior to this, Françoise worked as an Economist for over five years at the equity broker Exane BNP Paribas in London. There, she was in charge of the macroeconomic analysis of the Chinese economy and Emerging Markets. She also worked on global and European topical themes. Her other work experiences include the ACPR, the French supervisor for the banking and insurance sectors.
Andreas (Andy) Jobst
Andy Jobst is global head of macroeconomic and capital market research at Allianz SE in Munich, where he is responsible for short-term surveillance and macroeconomic forecasts as well as analysing long-term trends and developments. Prior to his appointment, Andy was a career economist at the International Monetary Fund (IMF) in Washington, DC (2005-2021). Andy also held senior positions during secondments – as adviser to the managing director and CFO of World Bank Group (2016-19), and chief economist and deputy director (supervision) at the Bermuda Monetary Authority (2011-14). Andy previously worked at the Federal Deposit Insurance Corporation, the Deutsche Bundesbank, the European Central Bank, the Bank of England, and Deutsche Bank (London) and was external adviser to the European Investment Bank.
Pablo Espinosa Uriel
Pablo Espinosa Uriel joined Allianz SE in 2020 as the capital markets analyst for emerging economies, where additionally he collaborates with the alternative investments team. Prior to this, he worked in the financial industry as a consultant, and as an economic assistant in various research institutes.
Zheng joined Allianz Trade as economic research assistant in July 2022. He is currently studying at the Paris Sciences & Lettres University (Paris Dauphine University) for his master’s in International Affairs and Development, specialised in International Economics. Before that, he received his bachelor’s degree in Economics from the Toulouse School of Economics.