Record foreign demand for Chinese assets will boost efforts to develop a more global role for the renminbi, analysts say.
Foreign investors have snapped up Chinese debt this year, lured by relatively high yields and the country’s strong economic recovery following the coronavirus pandemic. Meanwhile, the People’s Bank of China has not sought to weaken the renminbi even after large rallies for both the onshore and internationally-traded versions of the currency.
The PBoC had encouraged inflows by promising in a report in August that “the allocation of the renminbi assets by foreign investors will be further facilitated”, adding that it expected “more foreign central banks and monetary authorities to hold renminbi (assets) as reserve assets”.
Investors and analysts say that as foreign investors increase their onshore Chinese holdings, the renminbi’s prospects as a reserve currency will probably get a boost.
“For internationalising a currency, you do need to have a large and liquid bond market and that’s what they’re doing,” said Denise Simon, co-head of emerging market debt at Lazard Asset Management.
Chinese policymakers have been keen to increase the international use of the renminbi for payments and investment — largely to reduce their reliance on the US dollar — following the currency’s deeper adoption by the IMF in 2016. But the year before, China’s central bank had engineered a decline in the currency, throttling reserve managers’ and investors’ appetite for the renminbi and onshore assets.
Five years on from that move, the picture is very different. Instead of slashing rates to combat the economic impact of the pandemic, China opted to rely more on fiscal support and kept its main rate relatively high, making these assets attractive when interest rates in other big economies are at zero or below.
“In the last couple of years there was a lot of caution towards the renminbi by many investors, and this year there’s been a complete flip in that mindset,” said Paul Mackel, head of emerging markets foreign exchange research at HSBC.
Investors have also been attracted to Chinese assets as an alternative to the US, where political risks, the economic effects of the Covid-19 crisis and interest rate cuts have weighed on the dollar.
“China’s economic fundamentals are very positive, the recovery has been stronger than elsewhere and there are no fears of a second wave of coronavirus,” said Kaspar Hense, a portfolio manager at BlueBay Asset Management.
Investors can earn a yield of about 2.7 per cent on 10-year Chinese government debt, compared with under 0.8 per cent on the equivalent US Treasury.
Flows into China’s onshore bond markets in the year to August topped Rmb615bn ($90bn), bringing foreign holdings to Rmb2.8tn. Net equity market inflows were Rmb93bn for the same period, taking foreign holdings to more than Rmb1tn.
Today, investors are less concerned about sudden exchange rate shifts than in recent years when the scars of the mini-devaluation lingered. The PBoC also reassured investors in its August report that the exchange rate moved in both directions “based on the market supply and demand”.
“Policymakers are letting the currency be more market-determined and the fundamentals don’t point to the kind of devaluation like in 2015,” said Ms Simon.
The past three months have delivered the best quarter for the onshore-traded Chinese currency since the global financial crisis, while the less-regulated offshore renminbi has gained about 7 per cent against the dollar since its May low, with little resistance from the PBoC.
Central bank reserve managers are also keen to diversify their holdings. UBS Asset Management’s annual survey showed “political developments in the US” — including social tensions — have replaced the risk of a “hard landing” for the Chinese economy as the third-biggest concern for central bank reserve managers this year, behind trade wars and a global slowdown.
The survey showed that reserve managers have also increased their 10-year renminbi allocation targets to 5 per cent, up almost 1 percentage point from last year. According to the latest data from the IMF, reserve managers have slightly more than 2 per cent of their currency reserves in the renminbi.
“If you are a reserve manager, return has to play a role. The fixed income investment case for China is very strong,” said Max Castelli, head of strategy for sovereign institutions at UBS Asset Management.
Still, the renminbi is hindered by a lack of full convertibility. The “global dominance of the dollar remains intact”, the Swiss asset manager’s survey concluded. The latest data from the IMF show that nearly 62 per cent of global reserves are held in dollars. “The rise of the renminbi as a reserve currency is not a sprint, it’s a marathon,” Mr Castelli said.
The country’s government debt will become part of one of the world’s main bond indices next year, which analysts estimate could mean an additional $140bn of inflows.
“The inclusion of Chinese assets into major bond and equity indices is a very strong indication of the PBoC’s intentions around . . . the renminbi and it clearly tells us that the central bank wants to move more towards liberalising its markets,” said Gaurav Mallik, chief portfolio strategist at State Street Global Advisors.