Will the US Dollar be Replaced by the Yuan?

The de-dollarization trend is here to stay, admit American experts, arguing, however, that there is still no replacement for the greenback, a freely convertible means of payment and a dominant reserve currency.

"There is a very good reason why the dollar is used widely in trade, and that's because we have deep, liquid, open capital markets, rule of law and long and deep financial instruments," insisted Treasury Secretary Janet Yellen last week.

However, Chairman of Russia's VTB Bank Andrei Kostin does not share Yellen's stance, projecting back in May that "there is every reason to expect that the Chinese yuan will replace the US dollar as the world's main reserve and settlement currency as early as the next decade." So, who is right?

On October 1, 2016, the Chinese yuan, or renminbi (RMB), joined the International Monetary Fund's (IMF) basket of reserve currencies that make up the Special Drawing Right (SDR). The basket previously included the US dollar, the euro, the Japanese yen, and the British pound.

The SDR, an international reserve asset, was created by the IMF in 1969 to supplement its member countries' official reserves. Per IMF, the yuan's inclusion in the SDR became an "important milestone" in the integration of the Chinese economy into the global financial system.

Skeptics say that the RMB is still not as widely used as the US dollar. The greenback remains the world's dominant currency being on one side of 88% of all trades as of April 2022, while the RMB was used in just 7% of all transactions. The yuan's share of the world foreign exchange reserves was less than 3% at the end of 2022, while the dollar and the euro boasted 58% and 20%, respectively.

Likewise, the renminbi's global share was 2.5% in May, as per the Society for Worldwide Interbank Financial Telecommunication (SWIFT), which is a far cry from the 43% for the greenback or 32% for the euro.

Western experts argue that China's capital controls and limited transparency of financial markets still prevent the yuan from becoming a major global currency. In response, their Chinese peers note that the yuan's primary feature is to "serve the real economy" adding that lax controls could lead to speculative demand for the Chinese currency.

The Chinese yuan has recently demonstrated the biggest increase in market share, leaping from 4% in 2019 to 7% in 2022 and becoming the fifth most traded currency up from 35th place in 2001. In addition, the RMB turned out to be the fifth-most-actively used currency for global payments as of April 2023, even though it ranked 30th in 2011.

China is pushing for the internationalization of the RMB. In 2015, it created the Cross-Border Interbank Payments System (CIPS) to facilitate cross-border payments in yuans. In 2018, the People's Republic kicked off the world’s first yuan-denominated crude oil futures contracts to make it possible for exporters to sell crude in renminbi.

Earlier, the People's Bank of China (PBOC) also began research on a digital currency in 2014 and kick-started testing in four cities around China in April 2020, namely, Shenzhen, Suzhou, Chengdu and Xiongan. In addition, China’s Alipay and Tencent pay have become widely adopted abroad.

Beijing's Belt and Road Initiative – a set of bold infrastructure projects and trade routes – has also facilitated the yuan's internationalization. China is also playing the role of a lender, with the government and enterprises offering hefty loans to developing countries.

Last year, the share of US-dollar-denominated foreign exchange reserves fell to 59.8% from 72% in 1999, according to the IMF.

Even though the yuan still lags behind the dollar and the euro, the unfolding geopolitical shift could potentially elevate it to a major currency status, according to international observers. After the beginning of Russia's special operation in Ukraine, the collective West curbed Russia's access to the global dollar-based payments system, SWIFT, and froze its central bank's assets. This situation demonstrated that the dollar could swiftly be turned into a punitive mechanism, triggering concerns among global players.

At the same time, the US Federal Reserve's aggressive interest rate hikes made the greenback especially expensive for foreign borrowers and those who paid for foods, raw materials and other commodities in US dollars. Prior to the Fed's move, Kristalina Georgieva, managing director of the IMF, warned in January 2022 that the US raising interest rates could backfire on the global economy and especially on countries with higher levels of dollar-denominated debt.

As the de-dollarization trend gained momentum, developing countries started to increasingly shift to the yuan or local currencies, seeing them as an antidote to Washington’s weaponization of the global financial system and use of alternative or domestic systems for international payments.

Having been banned from the dollar-centered financial system, Russia has shifted to payments in the yuan for its oil and natural gas. Earlier this year, the RMB replaced the greenback as the most traded currency in Russia. Likewise, Russia's Finance Ministry doubled the amount of RMB and gold in the national wealth fund.

Some Russian companies, such as Rosneft, issued bonds denominated in renminbi. In March 2023, the offering amounted to ¥15 billion, with a coupon rate of 3.5% per annum. Per Rosneft, "in ruble terms, this placement is the largest of the corporate issues currently in circulation."

For its part, Argentina has shifted to RMB to tackle its currency crisis: as the country is facing a dire shortage of US dollars, it allowed commercial banks to open deposit accounts in the Chinese currency, according to the Argentine Central Bank's Thursday statement. The Latin American nation is also expected to issue securities in the Chinese currency. Earlier, in April, Argentina started to pay for imports from China in RMB.

Earlier this year, Brazil and China struck an agreement to use both of their currencies in bilateral trade which is worth about $163 billion a year. It was reported in April that Bangladesh would be paying Russia in RMB for the construction of a nuclear power station. In March, China's national energy giant CNOOC and France's TotalEnergies completed their first yuan-settled liquefied natural gas (LNG) deal through the Shanghai Petroleum and Natural Gas Exchange.

Likewise, in February, it turned out that Baghdad was planning to pay for private-sector imports from China in RMB to decrease pressure on the Iraqi dinar. The same month it was reported that TESCO, a British supermarket chain, decided to pay its Chinese suppliers in yuan.

Chinese media has recently admitted that while the yuan had made marked progress in internationalization, it had fallen in value against the US dollar. Last week, the Chinese currency hit a seven-month low against the greenback, raising questions whether the nation's monetary authorities would interfere.

Earlier this week the People’s Bank of China (PBOC) issued strong guidance with regard to the Chinese currency's exchange rates, while Pan Gongsheng, chief of the State Administration of Foreign Exchange, was appointed as chief of the Central Bank late last week.

Even though the depreciation of the renminbi is cited as a huge challenge for the newly appointed PBOC chief, Chinese observers believe the yuan has no basis for a long-term slide. As per the Global Times, as the de-dollarization trend gains steam, the proportion of enterprises using renminbi settlement in trade has increased. With more liquidity having been injected into the world's financial system to meet rising demand for the yuan, the currency's fluctuations appeared predictable, the media noted, expecting the renminbi global share to grow further.