via Chinese yuan could be a boon to Zim traders | The Herald January 28, 2016
The recent visit by the Chinese President Xi Jinping to Africa and Zimbabwe in particular generated considerable excitement and anxiety in the generality of Zimbabweans and policy makers alike.
What stands out clear from President Xi’s visit is China’s increasing interest in Africa, which will see growth in trade and therefore the flow of finance between the Asian country and Africa.
China’s inclination towards Africa might be a response to the global economic rebalancing that is taking a toll on its economy.
China may have to rebalance its economy by reducing investments and exports in favour of domestic consumption otherwise it will experience an overcapacity problem in the wake of reduced demand from the West.
However, due to sticky domestic demand, China may have to find a new home for its investments and exports so as to avoid a possible hard landing scenario, which may be painful for its economy.
Africa’s trade with China is estimated to have reached $385 billion by the end of last year, which is a 20 percent growth from the previous year amount.
This has created increased demand for cross-border yuan (unit of Renminbi) settlements. However, limited yuan tradability has resulted in extra transactional costs on deals between China and its trading partners.
Transactions have to be first settled in the US dollar, the leading reserve currency, and then converted to the host country’s currency.
Because of its global economic influence as the second largest economy in the world and the largest consumer of commodities, China has pushed for the yuan’s inclusion in the Special Drawing Rights (SDR) basket, which was granted effective October 2016.
The yuan would provide a better trading alternative to the US dollar, Japanese yen, sterling pound (GBP) and euro which are currently officially recognised by IMF as international foreign exchange reserve assets.
It will also cushion African nations from inordinate exposure to the US dollar and thus minimise the risk of depletion of national wealth in the event of dollar depreciation.
With more than $3,8 trillion in US dollar denominated international reserves, China might have to convert some of its reserves into its own currency over time so as to prop up yuan liquidity and support its internationalisation.
A currency is internationalised when market participants – residents and non-residents – can conveniently use it to conduct economic and financial activities including trade, investment and offshore invoicing.
However, the dollar sell-off would have to be done gradually to avoid possible dollar depreciation, which will diminish the value of China’s US dollar denominated reserves.
Dollar depreciation would also mean a stronger yuan, which is incompatible with China’s export led growth model.
According to IMF, there were 204 billion Special Drawing Rights (SDR) allocations at the end of 2015.
The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves.
Its value is currently based on a basket of four key international currencies alluded to above, and SDRs can be exchanged for freely usable currencies.
The value of the SDR is approximately $1,4 per unit so total SDR allocations convert to $285,6 billion.
Total global exchange rate reserves are estimated at $11,46 trillion as at the end of 2015. Thus total SDR assets account for 2,5 percent of global reserves. The Chinese Renminbi (RMB) has been allocated a weight of 10,92 percent in the SDR basket while US dollar carries a weight of 43 percent.
Other currencies’ weights are 30,9 percent for the euro, 8,09 percent for the pound and 8,33 percent for the Japanese yen.
The total RMB assets currently stand at $98 billion which is equivalent 0,86 percent of the global reserves and only insignificant fraction of China’s total reserves of $3,8 trillion, which demonstrate huge potential for the Renminbi to provide the necessary liquidity expected of an international reserve currency.
Research has shown that the currencies in the SDR basket tend to move in the same direction, such that a possible US dollar depreciation would have wide and synchronised effects on the whole world.
The recent global financial crises bears testimony to this proposition. The yuan will neutralise the dollar dominance in the SDR basket and thus shield traders from exchange rate risk as it is not highly correlated to the US dollar.
The collapse of the US dollar during the global financial crises saw synchronised depletion of national wealth to especially those countries that had huge exposures to the US dollar.
The US households, for example, suffered a more than 60 percent reduction in their wealth following the global financial crises.
One benefit that can flow out of RMB internationalisation to a country like Zimbabwe is possible extension of credit in order to alleviate the trade concentration effect of dollar shortage.
In period post global financial crises period, China entered into some bilateral currency swap agreements with a number developed and developing economies with the aim to provide liquidity support to its trading partners in the wake of dollar challenges.
This was done as part of China’s RMB internationalisation project. These swap agreements allowed extension of trade finance to importers of Chinese products.
By end of 2012, People Bank of China (PBoC) had entered into currency swap agreements with the central banks of 19 countries and regions including Argentina, Australia, Brazil, Indonesia, Japan, Korea, Malesia, New Zealand and Singapore with total value of $320,3 billion.
It makes economic sense for China to offer credit to the importers of its products so as to support its export led growth model.
This is exactly what they have been doing with the West. China’s $3,8 trillion reserves are largely held in US treasury bills thus providing liquidity support to the US economy, which enabled the latter to buy more Chinese products.
But as the West consumption binge is slowly withdrawn China may have to start developing the African market by providing liquidity and current account support so as to complement demand from the West.
China has already written off some $40 million debt for Zimbabwe, a development which gives hope to its readiness to work with Zimbabwe. Recently, China pledged $60 billion financing for development across Africa.
It also concluded 12 mega investment deals worth $4 billion with Zimbabwe in areas of power generation, transport and communication infrastructure and manufacturing.
Trade between the two countries topped $1billion for the year ended December 31, 2015 making China the country’s second largest trading partner after South Africa.
If the rand is the second mostly used currency in Zimbabwe, surely the trade levels between Zimbabwe and China should be reflected in RMB usage in the former country.
There is therefore need to promote the usage of the RMB in Zimbabwe for the obvious reasons I have alluded to before namely to minimise transactional costs, reduce inordinate exposure to the US dollar, minimise exchange rate risk and importantly to benefit from possible extension of credit by China.
The Ministry of Finance and Reserve Bank of Zimbabwe have already started promoting the yuan usage in Zimbabwe having issued press statements to this effect.
However, it is important to note that the successful promotion of the yuan is largely dependent on the availability of a yuan clearing house.
A clearing house will ensure a flawless payment system that does not have to go through another intermediary currency.
With a clearing house cheques/payments could be processed locally through an agreement between the two central banks thus expediting payments and easing the cost of trade.
Kenya is spearheading the project to establish a yuan clearing house in Africa which will make it easier for a number of African countries to start using the yuan. South Africa has also expressed interest in the project.
We wait to hear from the monetary policy statement to be announced later this month how the yuan project would be rolled out in Zimbabwe.
I think the promotion of yuan usage would
have to start with banks and obviously supported by clearing house and then extended to retail sector.
If the large stores start accepting the yuan, its use can easily be promoted given the dominance of the retail sector in the Zimbabwe economy.
While the merits of increased yuan usage in Zimbabwe are clear it must be emphasised that a currency alone is not a panacea to Zimbabwe economic problems.
The whole value chain should start with increase production and the currency issue will only aid in easing trade challenges.
The real issues lies in attracting FDI, given limited investible resources locally and efficient deployment of capital towards economic growth and development.
However, FDI can only flow to countries where conditions of doing business are sound. There is therefore need to improve the easy of doing business in Zimbabwe.
I understand there is a lot of work being done in this area. This will be complemented with clarity on the indigenisation laws and continuous fine tuning of these laws to reflect the global realities.
Importantly to attract FDI there is need for a sound industry strategy. The world is moving toward economic clusters for the advantages they offer as an industry growth strategy. Globalisation diminished the competitive advantage of resource based industries hence there need to value add our primary products.
Resource based industries should be buttressed by close location of related industries in the value chain. This is the whole idea of clustering. Mutare for example, can develop a cluster for diamonds and all related industries should be located in this area. The country can also develop a tobacco cluster where tobacco activities are concentrated.
This idea can be extended to the rest of Zimbabwe’s industries. Industry clusters can easily attract FDI and benefit from technological and knowledge transfer. This is what Zimbabwe needs at the moment!!!
Persistence Gwanyanya is an Economist and Banker. He is also a member of the Zimbabwe Economics Society. He writes in his personal capacity and this article does not represent the views of his employer. For feedback you can use my email address firstname.lastname@example.org or WhatsApp on +263 773 030 691.