The investment outlook for renminbi-denominated assets

Bank of China (Hong Kong) assesses the prospects for renminbi-denominated assets as GDP growth slows worldwide

Despite changes in the international economic environment, China has shown it can still achieve high-quality economic growth and maintain stability in its financial system while preventing the spread of Covid-19. Driven by market demand, renminbi internationalisation has been further consolidated and the scale of renminbi current account settlement has reached a record high. The renminbi is now China’s second-largest cross-border payment currency, the world’s third-largest special drawing rights (SDR) basket currency, the fourth-largest global payment currency and the fifth-largest international reserve currency. This emphasises the resilience of China’s economy. This article analyses the potential of investing in renminbi assets from three aspects:

1. China’s economic situation

2. The characteristics of renminbi assets

3. The future development of renminbi internationalisation.

China’s economy

China’s economy grew 8.1% in 2021, reaching its fastest growth rate in a decade. Since the beginning of 2022, as the global economy encounters a number of uncertainties, China has adopted a steady strategy to progress its economic development.

China has demonstrated its economic resilience over the years – maintaining stable economic growth relatively well during the economic turmoil of the Covid‑19 pandemic. According to the latest data from the National Bureau of Statistics of China, the nation’s economy continued to recover, with a stable start to 2022. The world’s second-largest economy’s GDP increased by 3.9% in the third quarter of 2022, compared with the same period last year, exceeding the 3.4% pace predicted by some previous analyses and picking up speed from the 0.4% growth recorded in Q2 2022. The data shows China’s economic resilience in three different areas. First, industrial production rose 6.3% between January and September. This strong growth rate indicates a solid development of the real economy. Second, in terms of consumption, China’s retail sales grew 2.5%.

This also reflects China’s proficient handling of economic turmoil, with stable consumption growth. Third, fixed-asset investment has experienced a good recovery growth trend, expanding by 5.9% year-on-year in the first nine months of 2022, signifying China’s potential economic growth.

However, with China’s zero-Covid policy and monetary policy shift among major economies, it is believed it will encounter pressure on its economic recovery. Yet, with current market environment changes, China has been actively supporting the economy and stabilising market expectations by providing policy support to the market. Its government has emphasised steady economic growth repeatedly in various high-level meetings. It also provided policy support to stabilise market expectations and promote development, investment and consumption to drive economic growth. For example, by:

1. Promoting tax reduction policies to reduce financial burdens on corporations

2. Reducing financial institutions’ reserve requirement ratio to increase market liquidity

3. Local governments issuing consumption vouchers to stimulate the real economy.

Regarding renminbi internationalisation, the International Monetary Fund’s (IMF’s) decision to increase the currency’s weighting in SDR – from 10.92% to 12.28% – is encouraging. It recognises China’s economic development and renminbi internationalisation efforts. There is believed to be an increasing trend of foreign holding in renminbi assets. Since the IMF included renminbi in the SDR basket in 2015, global foreign exchange reserves in renminbi increased from $90.3 billion in Q4 2016 to $336.1 billion in Q4 2021 – up 3.7 times in five years. Meanwhile, the latest Currency Composition of Foreign Exchange Reserves data showed that the renminbi remained the world’s fifth-largest reserve currency, with a rise in its share to 2.88% – the highest since the report was first published in Q4 of 2016. According to Swift’s latest data, although the renminbi exchange rate fell in April, the renminbi accounted for 2.44% of global payments in September – up from 2.3% from a month earlier. The renminbi also maintained its status as the fifth-most active payment currency worldwide.

Indicating the rising market share of China’s exports, 2021 saw cumulative year-on-year growth in exports of chemical products (41%), labour-intensive products and non-ferrous metals (16.5%), and mechanical, electrical and high-tech products (24.5%), emphasising China’s international status, supply chain resilience and economic strength in global industry during the pandemic era.

Renminbi asset characteristics

Renminbi assets have attracted global investors, mainly because of the currency’s low correlation with other risky assets. Investing in renminbi assets can achieve risk diversification while capturing stable returns. Take renminbi bonds for example: when global economic growth was weak and the financial market was experiencing high volatility – particularly in recent years when the global economy has been affected by the pandemic – more foreign institutional investors increased holdings in renminbi bonds. According to the People’s Bank of China, the nation’s bond market balance reached CNY138.2 trillion in April this year. China has been the second-largest bond market worldwide since 2016.

Meanwhile, 1,035 foreign institutional investors have entered China’s bond market, with a total holding of CNY3.9 trillion worth of bonds – up 225% from the end of 2017. Long-term investors don’t seek to speculate on short-term yield spread or arbitrage opportunities, but look for relatively stable investments and mid- to long-term returns in different markets. This can be achieved by entering China’s government bonds market and investing in renminbi bonds.

Compared with the volatile state of the international financial markets and the uncertain international environment, China’s economy’s relatively steady growth has endowed renminbi assets with better risk resilience than other assets. Multiple uncertain economic factors have caused some foreign nations to encounter high inflation rates, while China’s newly released consumer price index was only 2.1% in October – a relatively lower inflation rate compared with other major economies. Amid high inflation worldwide, China has a relatively stable environment in energy and food prices. As a global manufacturing country, its strong global industrial position in supply chain and production contributed to China’s economic stability. China’s economic growth is one of the highest among major economies but, at the same time, its inflation is low. These positive factors all contribute to the currency’s safe-haven characteristics, increasing renminbi assets’ attractiveness.

Future international development of renminbi

After years of renminbi internationalisation and more offshore institutions – such as central banks, financial institutions and corporations – increasing their holdings in renminbi, the currency’s usage experienced a significant change. The renminbi’s function has diversified from a settlement currency to an investment and hedging currency. The renminbi has also steadily developed as an investment and reserve currency. For example, Brazil increased the renminbi share of its FX reserves from 1.21% in 2020 to 4.99% in 2021. According to Goldman Sachs, renminbi holdings in four Latin American countries – Brazil, Chile, Mexico and Peru – are close to $30 billion, up about 10 times from the end of 2018. Israel, meanwhile, is expected to invest 2% of its FX reserves in renminbi from 2022. With the gradual internationalisation progress, the renminbi’s exchange rate is expected to trade with a healthy two-way fluctuation, with more market-driven characteristics.

Recently, the renminbi’s exchange rate has experienced considerable fluctuation. From late April to early November, it depreciated from 6.37 against the US dollar to 7.32. Reasons for this rapid depreciation include the effects on China’s economy of a regional Covid-19 outbreak and the US Federal Reserve’s decision to raise interest rates in early May and shrink its balance sheet in June. The US-China government bond yield spread narrowed and even inverted, causing foreign capital outflow. Because of that, risk-off sentiment was developed in the FX market. After market adjustment and priced-in negative factors, the depreciation of the renminbi subsided and the market stabilised. The renminbi market correction also came to an end and started to rally, returning back to 7.10 against the dollar, which highlights the fundamental strength of the renminbi and indicates that it will not depreciate over the long term.

The Fed has been increasing the pace at which it is raising interest rates and reducing its balance sheet. At the same time, most nations have begun tightening their monetary policies, which contrasted with China’s monetary policy stance, causing a central bank policy divergence. However, to some extent, monetary policy tightening in western countries was driven by previous monetary easing policy. In contrast, the People’s Bank of China maintained a supportive monetary policy stance as a result of previously maintaining prudent monetary policy. In recent years, through the development of China’s real economy, it has accumulated a balance of payments surplus, which has become an important support for the renminbi exchange rate, ensuring steadiness.

The narrowing – and even inversion – of government bond yield spread may continue due to divergence in economic cycles and monetary policies between China and the US. Uncertainties – such as those resulting from current geopolitical situations – still exist, and the renminbi’s exchange rate is expected to fluctuate in the short term. However, in the long term, with the steady opening-up of China’s financial market, renminbi assets remain attractive to foreign investors. The fundamentals of China’s economy remain unchanged, and with sufficient policy tools, the renminbi’s exchange rate is expected to remain stable at an appropriate level.

Renminbi reserve assets

To conclude, after the increase of renminbi weighting in SDR, it is possible more and more central banks will increase renminbi in their FX reserves, which will help promote renminbi internationalisation. Meanwhile, as the pandemic slowly continues to come under control and China’s economy steadily grows, its assets will become more attractive. It is hoped that more central banks, financial institutions, corporates and even individuals will increase their investment in renminbi assets in the future for satisfactory returns.

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