ORLANDO, Florida, April 11 (Reuters) – Far from cementing itself as a world reserve currency, China’s yuan has gone into reverse and its share of global foreign exchange reserves has fallen to the lowest level in three years.
The gradual but steady decline since early 2022 reflects the international community’s unease about investing in China, which was crystallized in huge foreign capital outflows from Chinese equity and bond markets last year.
While China’s economy finally seems to be emerging from its post-lockdown funk in the wake of COVID-19, there are plenty of reasons reserve managers may still need convincing to start re-loading up on the renminbi, or yuan.
China is a global economic and financial superpower, and the yuan’s role in cross-border trade and transactions is rising. But there are questions over its economic might, unease over its capital controls, and concern over its geopolitical alliances and militarism.
The yuan’s allure as a global reserve currency is fading.
The International Monetary Fund’s latest composition of foreign exchange reserves (Cofer) data show that of the world’s $11.45 trillion in FX reserves where the currency breakdown is known, 2.29% was in renminbi at the end of last year.
That is the lowest share since the fourth quarter of 2020, and down substantially from the 2.83% peak in the first quarter of 2022.
Central banks and reserve managers around the world have reduced their yuan allocation in each of the last seven quarters. In nearly two years, the yuan share of their FX reserves has shrunk by a fifth.
Michael Cahill, an FX strategist at Goldman Sachs in London, notes that Chinese government bonds no longer offer reserve managers the yield premium over developed world bonds that they did when the IMF first included the yuan in its Cofer data in 2016.
And it’s no coincidence that the Chinese currency’s FX reserve footprint began to shrink in the first quarter of 2022, when Beijing’s ally Russia invaded Ukraine.
“It is also certainly possible that geopolitics have played a role. Academic literature has found that reserve management is in part dictated by geopolitical alignment, and that certainly seems consistent with what we have seen,” Cahill says.
CLEAR TREND
Of the 10 countries that regularly report a geographic breakdown of their reserve holdings, none have increased their yuan holdings since the first quarter of 2022.
While these detailed reports represent only a small fraction of global reserves, Cahill reckons their stance on the yuan signals a “notable shift” in FX reserve management.
Visibility around Russia’s FX reserves dimmed after the invasion of Ukraine. But at the end of 2021 Russia was the largest holder of yuan reserves, with around a third of all internationally held yuan-denominated reserves, according to analysts at ING.
They also reckon Moscow may have reduced that stash after the invasion as it had to sell reserves to finance its ballooning budget deficit.
On the other hand, some smaller countries outside of the 149 nations included in the IMF’s Cofer data set may well have increased the yuan-denominated share of their FX reserves in the last couple of years.
In short, it is hard to measure FX reserves flows with real certainty but as ING points out, the general picture is clear – the renminbi is only one of two currencies, along with the euro, whose share of global FX reserves fell over the 2022-23 two-year period.
This is an unequivocal reversal from the yuan’s early days as a global reserve currency. The IMF’s Cofer data show its first share of reported FX reserves at the end of 2016 was 1.08%, which nearly tripled to a peak of 2.83% in early 2022.
In nominal terms, yuan-denominated FX reserves started at $90.8 billion and reached a high of $337.3 billion in late 2021. They ended last year at $261.7 billion.
The yuan’s share of reserves is falling in exchange rate-adjusted terms too, according to Goldman Sachs. They also hit a three-year low at the end of last year, although the decline has been more gradual and the previous peak was not as high.
Reserve managers tend to be conservative, and changes in currency allocations tend to be gradual. That’s because managers tend to lean against exchange rate moves in order to keep their make up of their reserves stable – that is, they buy more of a currency when it is weakening.
But according to analysts at JP Morgan, the yuan has been the “clearest exception” to this rule recently. Diversification away from the yuan has continued despite the currency’s 10% slide against the dollar in the 2022-23 period.
(The opinions expressed here are those of the author, a columnist for Reuters.)
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By Jamie McGeever; Editing by Hugh Lawson
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Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias.
