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China’s Yuan Decades From Challenging Dollar: Cutting Research

August 16, 2012

China’s Yuan Decades From Challenging Dollar

The yuan is involved in less than 1 percent of average daily turnover in global currency markets, somewhere between the Russian ruble and the Turkish new lira, said Alistair Thornton, an economist at IHS Global Insight in Beijing, citing data from the Bank for International Settlements. Photographer: Andrew Harrer/Bloomberg

To see the status of China’s yuan as a major reserve currency in two decades, one need only look at the yen.

The internationalization of Japan’s currency in the 1970s and 1980s boosted its use in trade settlements, fostered global samurai bonds and made it a mainstay of foreign-exchange markets, said Alistair Thornton, an economist at IHS Global Insight in Beijing. Then its star faded, a victim of government reluctance to fully open financial markets to foreign participants and focus on developing financial products, Thornton wrote in an Aug. 14 report on the website of the Sydney-based Lowy Institute. The global proportion of yen reserve holdings peaked at 9 percent in 1991, before falling to about 3 percent, he said.

That same fate may befall China. After accelerating the internationalization of the yuan, fundamental changes in China’s economic model including an open capital account, a floating currency and financial-market liberalization are needed to move toward achieving reserve status, Thornton said.

“It requires facing down tough political opposition and powerful vested interests, a willingness to expose the economy to new and unknown stresses and external volatilities, and a recognition that China needs to implement one of the largest sets of economic and financial reforms in recent history,” he said. “Against a backdrop of a weak and uncertain outlook in the global economy, it would be unsurprising if leaders in China receded into policy conservatism.”

The yuan is involved in less than 1 percent of average daily turnover in global currency markets, somewhere between the Russian ruble and the Turkish new lira, Thornton said, citing data from the Bank for International Settlements. That compares with 85 percent for the U.S. dollar and about 40 percent for the euro.

“Whilst some measure of internationalization is indeed underway, movement towards a reserve currency status commensurate with China’s global economic status will be tortuously slow, relegating the prospect to irrelevance,” he said. “The very best Beijing can hope for within the next couple of decades is a renminbi similar in position to that of the Japanese yen -- an internationalized, but modestly used, reserve currency. Even that will prove a stretch.”

* * *

The unexpected drop in India’s inflation rate last month to a 32-month low is a “mirage” that will be dispelled when food prices rise after poor monsoon rains, according to Anand Rathi Financial Services Ltd. in Mumbai.

The benchmark wholesale-price index increased 6.87 percent in July from a year earlier, compared with 7.25 percent in June, as vegetable prices fell 5.6 percent from a month earlier. That decline was unprecedented given that the costs of two major staples -- onions and potatoes -- surged, Anand Rathi’s chief economist, Sujan Hajra, and analyst Gautam Singh wrote in an Aug. 14 report.

The “drop in vegetable prices came as a major surprise as such a situation had never occurred in the past,” they said.

Monsoon rains have been 15 percent below typical. Should they fail to pick up before the end of the rainy season, it will push food-price gains to 18 percent and wholesale-price inflation above 10 percent by December, they said. Even if rainfall does improve, food inflation may peak at 14 percent and wholesale prices may rise 8.5 percent by year-end, they predict.

While the July inflation numbers raised the prospect of a cut in the benchmark repurchase rate by the Reserve Bank of India as early as September, Hajra and Singh say price pressures will prevent a further reduction before December. The bank has kept the rate at 8 percent since April, when it announced the first cut in three years.

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European Central Bank proposals to tackle Italy’s public finances have little chance of gaining popular support in the country, says economist Edward Hugh. Public resistance to the plans is likely to make politics in the euro-area’s third- biggest economy as fragmented and unstable as in Greece, Hugh wrote in “Is The Italian Elephant About to Break Loose Again?” posted Aug. 10 on the EconoMonitor website.

The ECB has urged Italy to cut wages and limit job protection, among other measures to stabilize finances, Hugh said. Italian politicians are reluctant to sign up to a rescue package from an institution with such views, raising pressure on Prime Minister Mario Monti not to ask for help.

Italy “really has no alternative” to a bailout if it wants to keep the euro, Hugh wrote. The government, which forecasts a contraction of 1.2 percent this year and growth of 0.5 percent in 2013, is “way too optimistic” given consumer confidence near a 14-year low and the purchasing manager survey for services showing lower output in a year. The lack of growth may push gross debt to GDP above 130 percent.

The prospect that Italians will have to suffer the strict conditions needed for a bailout and retention of the euro is fueling support for politicians ambivalent or openly hostile to the euro, delaying reform, Hugh said.

“The growing popularity of new political movements like Beppe Grillo’s Five Star could easily lead to the kind of political fragmentation already seen in Greece,” he wrote. That will make “traditional political forces which back the Monti government even more reluctant to accelerate the adoption of far-reaching reform.”

* * *

The U.S., euro area and Japan should consider policies to draw more older people into the workforce, including raising the retirement age, to offset a drag on growth from aging populations, says Nathan Sheets, global head of international economics at Citigroup Inc.

The three regions will experience per capita gross domestic product growth of about 0.5 percent to 1.5 percent over the next few decades, Sheets wrote in a research note published Aug. 9. His study of real GDP growth since 1991 shows the U.S. expanded an average of 2.5 percent a year, while the euro area grew 1.5 percent and Japan 0.75 percent.

Sheets’ analysis of Japan’s economy over the last 20 years shows its weakness didn’t come from a loss in productivity, which expanded at about the same pace as in the U.S. Instead, stagnant growth reflected a drop in aggregate hours worked, which partly resulted from a decline in labor demand as companies adopted conservative hiring practices, Sheets said. Hours worked fell 15 percent, compared with a rise of 15 percent in the U.S. and a 5 percent gain in Europe.

With limited prospects for bolstering economies by increasing the size of the labor pool, even allowing for attracting more women into the workforce, the nations will have to turn to their seniors, he said.

“Additional gains in labor-force participation rates in all three economies will need to come from the rising participation of older workers, especially given the fact that shifting demographics imply that older people will account for a larger share of the population,” Sheets said. “As an economic-policy measure, moves to encourage the participation of older workers (including higher retirement ages) would seem well advised.”

To contact the reporters on this story: Shamim Adam in Singapore at; Jennifer Ryan in London at

To contact the editor responsible for this story: Stephanie Phang at

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