Yuan’s Haven Status Won’t Stick Until China Relaxes Its Controls

When the world’s financial markets hit turbulence, could you really turn to China’s yuan as a store of value?

The idea of the yuan as a refuge has gained some traction in recent weeks as it capped its best quarter in 12 years relative to the dollar. That label would put it on par with currencies traditionally deemed as safe in a market downturn, like the Japanese yen or Swiss franc.

In addition to dollar weakness, the yuan is being underpinned by a wide interest-rate premium over the rest of the world, as well as signs that China’s economy is recovering from the shock of the pandemic. But unlike a haven, China’s tightly-managed currency is gaining just as money flows into risk assets such as U.S. stocks or high-yield credit. In other words, it is strengthening in a relatively benign market.

Buying the yuan as a shelter from market volatility isn’t new: in 2017, the Chinese currency proved to be a better bet than the yen when North Korea fired missiles into the Sea of Japan. But history also shows it’s a risky strategy — when the yuan showed haven-like resilience in early 2018, it slumped to a decade low that year after the Trump administration slapped its first tariffs on Chinese goods.

Considering the policy risk in China and its capital controls, viewing the yuan as a haven will be inappropriate, according to George Magnus, research associate at Oxford University’s China Centre.

“The yuan can be considered a ‘good trade,’ which is a cyclical phenomenon and has nothing to do with haven status — the conditions for that are largely unfulfilled,” said Magnus. “It is not and cannot be, as things stand, a viable alternative to the dollar or the euro, which have economic and institutional properties to which Xi’s China’s yuan cannot aspire.”

The central bank maintains a tight grip on its currency, and can often dictate its direction with the fixing which restricts movement by 2% on either side. The People’s Bank of China has recently allowed gains in the yuan, on Friday setting its daily reference rate at a stronger-than-expected level.

But on Saturday, the PBOC made betting against the yuan cheaper, a sign that it may be growing uncomfortable with the currency’s rapid appreciation. It reduced the cost of trading some foreign-exchange forwards, or derivatives often used to speculate against currencies, to zero from 20%.

A haven yuan would require China to have a more liquid financial market and open capital account, according to Eswar Prasad, a senior fellow at Brookings Institution. China would also need to show some of the key elements of an institutional framework, such as an independent central bank and a political system that’s typically associated with a democratic government, said Prasad, who once led the International Monetary Fund’s China team.

The Communist Party also controls the amount of money flowing out of the country, with citizens permitted $50,000 worth of foreign exchange purchases per year.

The yuan jumped about 4% in the three months through September, the largest quarterly gain since early 2008 and beating the Swiss franc and Japanese yen. The yuan is also particularly stable, with expected swings the lowest among 30 major exchange rates apart from the pegged Hong Kong dollar.

Haven or not, the yuan will likely stay strong given the attractive yield of China’s 10-year government bonds, which is at the highest since December. FTSE Russell, Bloomberg Barclays and JPMorgan Chase & Co. now include onshore bonds in their indexes, a move that will help attract steady capital inflows in the coming years. Bloomberg LP owns Bloomberg Barclays and Bloomberg News.

“Investing in China is likely to remain a good bet as the economy strengthens, and with it the renminbi’s value,” said Prasad, using the yuan’s official name. “But that does not mean the currency has become a safe haven. It is unlikely that the renminbi will be seen as a true safe haven currency in the absence of more far-reaching institutional reforms, which appear unlikely.”

– Bloomberg