Cai Jin

Pricing oil in yuan may be next move in China's currency ambitions

Attempt to wean world off US-dollar priced oil would mark another milestone for yuan

While the world's media is fixated over Chinese President Xi Jinping cementing his role as the most powerful leader in his country since Mao Zedong, it is worthwhile to note what China is doing to bolster its growing financial clout.

Much has been written about its emergence as a major exporter of capital that would inevitably increase its companies' ownership of physical and intellectual assets in Europe and the United States.

Copious amounts of column inches have also been written about China's One Belt, One Road initiative to develop new markets for Chinese companies across Europe and Asia, creating infrastructural links that stretch across central and south Asia towards Europe and Africa.

In Singapore, the use of the Chinese currency in commerce continues to grow from strength to strength, with yuan-clearing volumes by the Industrial and Commercial Bank of China Singapore hitting an accumulated total of 170 trillion yuan (S$34.9 trillion) as at the end of July.

However, on one front, there is a conspicuous lack of discussion - the internationalisation of the Chinese currency. That would seem odd considering the great efforts made by China to turn the yuan into a reserve currency by becoming the fifth currency in the basket that formed the International Monetary Fund's (IMF) Special Drawing Right.

Not to mention the growing role which Chinese equities now play in international investors' portfolios. Stock index provider MSCI announced in June that it would add 222 China A-shares, traded on mainland bourses, to its benchmark emerging markets index from next year.

Some market pundits believe the next push to further internationalise the yuan will come in the form of a drive by Beijing to price oil in the Chinese currency. China is now the world's biggest importer of oil. It would not be surprising if it tries
Some market pundits believe the next push to further internationalise the yuan will come in the form of a drive by Beijing to price oil in the Chinese currency. China is now the world's biggest importer of oil. It would not be surprising if it tries to price its oil purchases in yuan rather than the US dollar. PHOTO: BLOOMBERG

Yet, as The Economist magazine recently noted, the yuan's international reach appeared to have faltered in the past two years.

While it has regained its rank as the world's fifth most active currency for international settlements this year, its monthly market share in international payments has slipped to 1.9 per cent in August from 2.8 per cent two years ago.

The Economist also noted that the use of the yuan to raise funds in the global bond markets over this two-year period has also fallen by half, as companies have chosen to raise funds within China.

What is interesting is that in Hong Kong, the largest offshore yuan market, yuan deposits have plunged by 47 per cent from their peak in December 2014.

As for the role of the yuan as a reserve currency, just 1.1 per cent of the foreign exchange reserves held by the world's governments are in yuan compared with 64 per cent for the United States dollar.

Still, there may be a simple explanation for what happened. Until August 2015, the Chinese currency had tracked the US dollar for as long as anyone could remember. But in that month, as a prelude to getting the yuan named as a reserve currency by the IMF, China decided to ditch its soft-peg to the greenback.

For a start, Beijing can count on its state-owned oil companies to adopt the yuan-based oil contracts in order to drum up trading activities and generate sufficient liquidity.

It is also likely to approach crude oil suppliers in the Middle East, Russia and Asia - some of which already accept yuan as payment for sale of their crude oil - to price their products off the Chinese benchmark.

Whether this new contract takes off remains to be seen, but it marks another chapter in China's ambitions to internationalise its currency.

As the move took place amid a stock market crash in Shanghai and a drop in China's monthly exports, the subsequent modest decline in the yuan was misinterpreted that the Chinese economy might be in worse shape than previously envisaged. This led to speculation about further falls in the yuan's value and forced the central bank to tighten capital controls and spend a fortune to prop it up.

But since January, China's foreign reserves have been growing again, while gross domestic product growth in the first half accelerated to 6.9 per cent from last year's 6.7 per cent.

In the light of these developments, it would not be surprising if there is a renewed push towards further internationalising the yuan.

As China's central bank noted recently, the scope of the yuan "will be further expanded in 2017 and usage channels will be further widened".

The internationalisation of the yuan will play a more active role in serving China's real economy and facilitating trade and investments, it added.

Some market pundits believe that the next push to further internationalise the yuan will come in the form of a drive by China to price oil in the Chinese currency.

Since a 1974 agreement between then US President Richard Nixon and Saudi Arabia's King Faisal, Saudi Arabia has accepted payments for nearly all of its oil exports in greenbacks. This move was followed by all the oil-producing countries of the Organisation of Petroleum Exporting Countries (Opec) the following year.

As a result, since virtually all global oil transactions are settled in US dollars, when a country does not have a surplus of US dollars, it must create a strategy to obtain them in order to buy oil. This forced many countries - especially those from Asia - to develop an export-led strategy with the US in order to exchange their goods and services for greenbacks they would need to buy oil in the global market.

It also leads them to build huge mountains of foreign reserves in US dollars and enables the US to keep its interest rates low because of the enormous demand for its currency.

But China is now the world's biggest importer of oil, with data from Opec showing that its total crude oil demand rose 6 per cent in July to 11.67 million barrels a day from a year earlier.

It would not be surprising if it tries to price its oil purchases in yuan rather than the US dollar.

According to US broadcaster CNBC, Beijing may introduce a new way to price oil in the coming years. But unlike the contracts based on the US dollar, this benchmark would use China's own currency.

The plan is to price oil in yuan using a gold-backed futures contract in Shanghai that will be able to compete with more established benchmarks such as West Texas Intermediate or Brent crude, both of which are US dollar-based.

Whether China succeeds in weaning oil majors and big-time traders off US dollar-priced oil remains to be seen - but it will mark another milestone in the country's ambitions to turn the yuan into a currency prized by the international financial markets.

For a start, Beijing can count on its state-owned oil companies to adopt the yuan-based oil contracts in order to drum up trading activities and generate sufficient liquidity. It is also likely to approach crude oil suppliers in the Middle East, Russia and Asia - some of which already accept yuan as payment for sale of their crude oil - to price their products off the Chinese benchmark.

Whether this new contract takes off remains to be seen, but it marks another chapter in China's ambitions to internationalise its currency.

A version of this article appeared in the print edition of The Straits Times on October 30, 2017, with the headline 'Pricing oil in yuan may be next move in China's currency ambitions'. Print Edition | Subscribe