Academic journal article The Lahore Journal of Economics

China's Belt and Road Initiative and the Rise of Yuan – Evidence from Pakistan

Academic journal article The Lahore Journal of Economics

China's Belt and Road Initiative and the Rise of Yuan – Evidence from Pakistan

Article excerpt

1.Introduction

The Chinese yuan is poised to become an international currency and play a major role in global finance, competing with other hard currencies to serve as a reserve currency, an intervention currency and a settlement currency. China's "One-Belt-One-Road" initiative (OBOR), later renamed as the Belt and Road Initiative (BRI), feeds into and strengthens this emerging role of the renminbi (CNY)1. Since the ChinaPakistan Economic Corridor (CPEC), a major part of BRI, is expected to considerably increase the financial flows between the two countries, the rise of the renminbi (RMB) carries significant implications for the management of Pakistan's foreign currency reserves and exchange rate. In this paper we study how the yuan has evolved over time vis-a-vis other hard currencies, and how it has been affected by CPEC projects. The analysis provides policy implications for the management of the Pakistan's foreign exchange.

The renminbi is being used increasingly in settling cross-border trade and financial transactions, areas in which the US dollar has so far held the dominant position. Park (2016) reviews the reasons behind renminbi internationalization and highlights the Chinese government's strategy. At present, around 62 percent of China's foreign exchange reserves are denominated in USD and 20 percent are in EUR, which is in line with reserves holdings of other emerging market countries (Drut et al., 2016). The People's Bank of China (PB°C) has started to diversify its FX reserves by holding other currencies with a particular emphasis on Asian currencies. Also, the yuan is becoming an increasing component of foreign exchange reserves around the world, as a growing number of central banks and sovereign wealth funds include renminbi reserves and investments. Drut et al. (2016) suggest that the yuan already serves as an anchor currency for several countries. Shu, He, and Cheng (2014) present empirical evidence of the renminbi's growing influence in the Asia-Pacific region. Their findings also suggest that China's regional influence is increasingly transmitted through financial channels. Patel (2016) finds that the yuan has become a reference currency rivaling the US dollar in East Asia within the past decade and indicates that export similarity plays a major role in increasing regional currency influence.

The IMF's decision to include the renminbi (RMB) in the SDR basket effective October 1, 2016 not only symbolizes worldwide recognition of Chinese yuan as an international currency, but also carries implications for international finance. This decision boosted the credibility of the yuan and global demand for the Chinese currency (Hongcai, 2015). As a result, the share of the yuan as a reserve currency held by the foreign central banks will necessarily increase. Given that a current-account deficit is unlikely for China in the short run, it is inevitable that the yuan will continue to flow abroad through capital account deficits. On the other hand, Wang (2015) argues that "the inclusion of the Chinese currency in the SDR basket may well play a facilitating role in China's financial liberalization, but it does not in itself transform the yuan into a global reserve currency."

The emergence of the yuan as an international currency is likely to have major consequences particularly for countries with large inflows of the Chinese capital, as in the case with Pakistan under CPEC. The internationalization of the yuan will challenge the capacity of these countries to steer macro-economic policies and to manage financial risks. Drut et al. (2016) argue that "the USD never had a real contender in the past, and a tripolar system (USD, EUR and CNY), more precisely a system of competing international currencies, may be unstable during some periods." This instability arises essentially due to the capacity and incentives for investors, including the central banks, to shift the composition of their international portfolios and FX reserves. …

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