What investors need to know about the Chinese yuan

One of the first countries in the world where currencies appeared was China: they began to use coins as early as the 7th century B.C. and banknotes in the 8th century A.D. There were different kinds of money used in different provinces during all these centuries, but the single official currency was introduced only in 1948 when the People’s Bank of China was founded. They issued the so-called “national currency” with a gold content equal to 0.22217 grams of pure gold for one unit, which was called the Yuan. In 1949, the currency was officially named Renminbi.

What is the difference between CNY and CNH?

The Chinese currency, Renminbi, has more than one type of stock, which is denoted as CNY and CNH. The Renminbi implies two rates: onshore (CNY) and offshore (CNH) yuan. The onshore yuan (CNY) exists only within mainland China and is regulated by the People’s Bank of China. The exchange rate for CNY is controlled and transactions within mainland China can only deviate by 2% from the prime rate.

The offshore yuan (CNH) is traded on foreign markets and is regulated by the Monetary Authority of Hong Kong. Its exchange rate is determined by the volume of trading. Chinese authorities often adjust the USD to CNY exchange rate by buying up CNH on the Hong Kong Exchange.

The exchange rate of the offshore yuan may differ from the onshore yuan as it is more volatile and influenced by additional market factors.

What affects the USD to CNY exchange rate?

The yuan is not a freely floating currency and is regulated by the monetary authority. The policy of the People’s Bank of China (PBOC) is to maintain stability in the USD to CNY exchange rate.

To keep the yuan stable, capital flows are controlled in China. The following tools can be utilized:

• Currency interventions, which were conducted during the COVID-19 pandemic.
• Changing reserve requirements for foreign currency deposits.
• Tightening requirements for foreign direct investment and private money transfers.

Additionally, the daily USDCNY base rate setting also influences the currency. Based on the previous day’s close and currency dynamics, the PBOC sets the USD to CNY rate, and then the yuan can fluctuate within a range of 2% in either direction.

The dynamics of the USD to CNY exchange rate in the near term may be affected by:

• Inflationary reversal and US recession risks.
• Possible changes in the “zero tolerance COVID-19” policy in China.
• Possible recovery of the real estate sector in China.

What are the risks for a trader using USD to CNY?

One of the main challenges of trading with the yuan is the limited liberalization of the currency market in China and geopolitical risks, which can result in the weakening of the yuan or the implementation of quasi-market methods of regulation by the authorities.

China’s financial system is not fully liberalized, with a relatively closed capital account and restrictions on capital repatriation. The People’s Bank of China sets the official exchange rate of $1 in Chinese Yuan on a daily basis, and the interbank foreign exchange market cannot deviate from that level by more than 2%. Consequently, the yuan is not considered a freely convertible currency. However, this characteristic allows the authorities to mitigate the adverse impact of external factors on the domestic financial market.

Geopolitical risks in the country remain high, particularly regarding regions like Taiwan. These risks can introduce additional volatility in the currency market or prompt the government to implement quasi-market reactions, such as the imposition of additional capital controls.

Why is the yuan gaining popularity around the world?

Interest in the renminbi (yuan) is increasing as China’s trade position strengthens. The country has become a leader in merchandise trade, accounting for over 15% of global exports and 13% of global imports by 2021.

Furthermore, the internationalization of the yuan is influenced by its role in international reserves. As of 2021, the U.S. dollar remained the dominant currency in global foreign exchange reserves, representing more than 59% of the total. However, there is a shift towards other currencies, including the yuan. By the end of 2021, the yuan accounted for approximately 3% of the total international reserves structure, compared to less than 1% in 2016. Although the yuan still trails behind the euro, dollar, and pound, it is used as a reserve currency in more than 70 countries worldwide.

The focus on strengthening the role of the national currency and reducing dependence on external factors is driven by geopolitical factors, such as trade wars with the United States. Chinese authorities have gradually lifted restrictions that hindered the yuan’s use in trade flows, facilitating its internationalization and reducing its reliance on external factors.

Yuan: an unconventional path to reserve currency status

Why is the currency of the world’s second-largest economy not playing a defining role as a reserve currency? The Chinese yuan’s 3% share of global reserves looks very pale compared to the US dollar (60%) and euro (20%). How can this difference be explained?

A common answer to this question is that the renminbi cannot develop as an international reserve currency until China fully liberalizes its capital account. This view is based on the assumption that other countries will not hold the renminbi in reserves unless they can easily buy and sell it on international markets.

However, it cannot be ruled out that the internationalization of the renminbi could happen in a very different way. Even in the absence of complete financial liberalization, it is possible that the renminbi could play a more important international role in the future, especially as a central bank reserve currency. China’s approach to the internationalization of its currency will not lead to RMB dominance but rather to a multipolar world of key currencies in which the dollar, euro, and renminbi will coexist.

Conclusions

Investing in the CNY can be a profitable option for those looking to protect their money from the fluctuations of the USD-CNY exchange rate. In addition, investing in this currency can bring additional profits in the form of returns on deposits or appreciation of the US dollar against the Chinese yuan. However, the decision to invest should be conscious and made by each investor individually, taking into account their objectives and risks.

Before investing in the yuan, it is worthwhile to study the Chinese economy, the global political situation, and other factors that may affect the USD-CNY exchange rate. Diversify your investment portfolio by considering different asset classes and countries to mitigate risks and achieve better results. Additionally, on our site, you can find the current USD to CLP exchange rate and information on other currency pairs.