Tag Archives: dollar

CIPS Replacement Of SWIFT Will Not Be Swift

Screenshot of page from SWIFT website captured February 27, 2022

THE DECISION BY Western nations to sanction some Russian banks by excluding them from the SWIFT messaging system that underpins international bank payments will spur Beijing to accelerate the adoption of its alternative.

At its core, SWIFT is a secure messaging system, as its full name — Society for Worldwide Interbank Financial Telecommunication — implies. Thus there is no reason that its functionality cannot be replicated.

China and Russia have had rivals since 2015, the Cross-Border International Payments System (CIPS) and the System for Transfer of Financial Messages (SPFS), respectively.

However, SWIFT’s power comes from its near-universal usage by more than 11,000 financial institutions across 212 countries, conducting 42 million transactions a day on average worth some $5 trillion.

By comparison, CIPS is in its infancy. It embraces only 80 foreign banks, including some Russian ones, but most of its 1,200 participant banks are Chinese or their overseas subsidiaries.

CIPS is mainly used domestically and for transactions between Hong Kong and the mainland. There is some regional use (8% of total CIPS transactions in 2020), but take-up is marginal in Africa, Latin America, and Europe.

In 2020, CIPS handled 2.2 million payment transactions across the year, with a total value of $7 trillion. However, that represented an increase over the previous year of about one-fifth for transaction volumes and approaching one-third for values.

CIPS has been getting more policy attention since the introduction of Hong Kong’s National Security law, which heightened concern over financial sanctions from the West. This has slightly shifted the focus from CIPS’s original goal of supporting yuan internationalisation to creating a SWIFT alternative should one become necessary.

SPFS, too, is used mainly domestically, accounting for around one-fifth of domestic financial payments. However, only a handful of international banks have signed up.

Neither system is anywhere near challenging SWIFT, even though Iran, which was kicked off SWIFT, in 2019, has declared it may soon be able to circumvent Western sanctions by using a combination of the Chinese and Russian alternatives to get around its own sanctions problems.

Its optimism is based on talks between Presidents Xi Jinping and Vladimir Putin in December. According to the Russian side, the two leaders agreed to develop a joint financial messaging and clearing system that would recruit numerous international banks. That will not happen overnight.

It is not a question of building out the systems. It is getting financial institutions to use them. SWIFT has more bells and whistles than CIPS and SPFS and can be used for capital transactions. Yet they are both still clearing and settlement systems, not rocket science. They just have to be reliable, efficient and cheap.

Usage has an element of chicken and egg. As long as so few global transactions are conducted in yuan, a Chinese clearing system will not attract many foreign adopters. Yet, if the system is little used, there is scant incentive for trade to be denominated in yuan.

Further, the strong network effects SWIFT enjoys also mean high user stickiness and substantial switching costs. This Bystander has read estimates that of the banks on CIPS and SPFS, only 10% of their transactions go through one or other of the services.

SWIFT is not a dollar-based system per se or even a US entity. It can clear in 26 currencies, operates from Belgium under Belgian law, and is overseen by Belgium’s central bank.

Yet SWIFT’s geopolitical power accrues to the United States as it is one of the critical props of the dollar’s centrality as a global currency. The dollar and euro have swapped primacy back and forth as the most used currency for international payments.

Yet, at around 40% each, both overshadow the yuan’s share of barely 3%, making it difficult for China to circumnavigate the Western financial system. The dollar’s use is the root of its global influence.

China would like the yuan to break the dollar’s hegemony over international trade. It has been actively pursuing bilateral currency swaps, such as its rolling three-year arrangement with Russia so that more trade can be settled in yuan. However, even its Belt and Road contracts tend to be dollar-denominated, and the bulk of China’s international trade is conducted in currencies other than the yuan.

Once that changes, which will likely require more relaxation of capital controls, CIPS is in place to facilitate that trade. But the cart can’t pull the horse.

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Yuan Shored Up Against Pressure From Washington And Tokyo

The U.S. Treasury has, as has become its custom, again declined to label China a currency manipulator. Its latest semi-annual report to Congress does say the yuan’s effective exchange rate remains “significantly undervalued” against the dollar, though it acknowledges that the Chinese currency has appreciated by 33.8% by that measure since currency reform started in 2005. It again calls for more exchange rate flexibility on Beijing’s part. All pretty much par for the course, and intended for domestic political consumption as much as anything.

More weight is given to its call for stronger policy changes on Beijing’s part to embed rebalancing. The Treasury remains concerned that the lessening of the surplus on the external account isn’t “enduring”. “Without more forceful structural reforms to promote domestic consumption, there is a risk that China’s imbalances will re-emerge as the global economy recovers,” it says. There would be little disagreement from this Bystander that further exchange rate reform is a necessary if far from sufficient condition for rebalancing.

In the meantime, the People’s Bank of China seems to have been intervening in the foreign exchange markets again on a large scale with activity intensifying since the fourth quarter of last year. The reversal in the slowing of foreign exchange reserve accumulation seen in the first three quarters of 2012 points to this.

This may as much as anything be being driven by the weakening of the yen ever since it became clear that Shinzo Abe would become prime minister last November. Though the official line in Tokyo is that the new government and its newly installed governor of the Bank of Japan aren’t targeting exchange rates, a weaker yen is a necessary precursor for the aggressive monetary policy aimed at achieving an domestic inflation target of 2% to work. Washington says it is monitoring the yen closely. With the yuan still closely tied by its 1% band to movements in the dollar, so is Beijing.

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Yuan-Yen Direct

Direct trading between the Chinese and Japanese currencies starts Friday, cutting out the dollar as an intermediary. Rates will be posted in Tokyo and Shanghai, with China’s monetary authorities allowing a 3% daily trading band for the yuan against the yen (the dollar gets a mere 1% band).

And so Beijing takes yet another step along the long road to the internationalization of the yuan. How long before the won joins in, a likely next step given the plans for a free trade agreement between China, Japan and South Korea?

There is no particular reason for trade not involving the U.S. to be exposed to the potential volatility of the dollar. Direct currency settlement should increase yuan settlement of China’s imports and exports, as it lessens the currency risk for Japanese and South Korean buyers of goods denominated in yuan. The same idea is behind plans for an agreement between China and its fellow Brics, Brazil, Russia, India and South Africa, to make loans in their own currencies to facilitate trade. The five Brics plus Japan and South Korea account for about 30% of world GDP, compared to 45% for the U.S., the U.K. and the Eurozone.

Greater use of the yuan in trade could eventually grow into full convertibility of the currency. Before then, though, there will need to be a loosening of China’s capital controls and more opening of China’s capital markets. Both represent a greater political challenge than expanding trade finance. Opponents of reform have been able to argue that China’s national interest has been well served by cross-border capital controls and the ring-fencing of the country’s financial system. Only beyond that still distant horizon lies reserve currency status.

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Yuan Again Said To Be In Balance With U.S. Dollar

At the end of a fraught week for China-U.S. relations on the diplomatic front, state media aren’t letting the economic side of the relationship get away scot free. The People’s Daily says that the yuan is in equilibrium with the dollar, and may even be too high (here via Reuters). The article, from the Chinese Academy of Social Sciences, the leading think tank, follows U.S. Treasury Secretary Timothy Geithner saying during the strategic dialogue talks this week that the currency should move higher against the greenback to allow for more flexible policy. The yuan has risen by almost a third against the dollar since the peg between the two was broken in 2005.

This is not the first time that Beijing has put forward the proposition that the yuan is now at a reasonable exchange rate against the dollar. Zhou Xiaochuan, governor of the People’s Bank of China, said as much earlier this week at a press conference during the talks, as did a Bank of China report in late March. None of that is likely to mollify American critics of China’s exchange-rate regime. Yet we are relieved, in one sense, to see the China-U.S. relationship returning to familiar ground.

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Beijing’s Currency Wars Playbook

Beijing will play its usual defense against the moves in the U.S. Senate to twist China’s arm to appreciate its currency against the dollar: vociferous denunciation of Washington for turning protectionist and initiating “trade wars” while patiently waiting out the start of any serious hostilities, calculating that the threat of them will eventually recede.

The denunciation has duly come with Foreign Ministry spokesman, Ma Zhaoxu, saying the bill now in front of the U.S. Senate proposing punitive measures against any country that is shown to be manipulating its currency — for which read China — “seriously violates rules of the World Trade Organization and obstructs China-U.S. trade ties”. He told U.S. Senators to abandon protectionism and stop politicizing economic issues. He also told them to “stop pressuring China through domestic law-making”. Co-ordinated sentiments have been expressed by the central bank and the commerce ministry.

While perhaps nobody outside the U.S. Congress really believes that a sharp revaluation of the yuan on its own will eradicate America’s trade deficit with China or create the new domestic jobs the U.S. is having such trouble generating, Beijing will know that even if the Democratic majority in the U.S. Senate passes the bill, the legislation will likely founder in the Republican controlled House of Representatives. Even if it does not, it is highly unlikely to survive a presidential veto. That is the past pattern of such proposed legislation. Support for this year’s bill appears to be stronger, helped by its narrower provisions and the background of sluggish U.S. growth and joblessness, but the odds remain long that it will become law.

At the very worst from China’s point of view, and the bill does become law, it will be cheaper politically for Beijing to fight any punitive measures through the WTO than it would to be seen to capitulate to foreign pressure. Meanwhile, it can bide its time, letting the gradual appreciation of the yuan that has been underway since June last year (up 7% against the dollar since then and 10% against the euro) ease the U.S. pressure, which is anyway likely to abate after next year’s U.S. elections. Simultaneously, it buys more time for the economy, particularly the export-manufacturing sector, to adapt.

China’s policymakers are quite happy for the yuan to appreciate. It will help them both fight inflation and restructure the economy. They just want do it to their timetable, not Washington’s–and they have the playbook to do that.

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Yuan Rising

By breaking through an exchange rate of 6.50 yuan to the dollar on Friday, China’s currency passed through one of those symbolic milestones beloved of market commentators. Thumbing through our records we see that level was last reached in 1993. A lot of Chinese exports have flowed under the bridge since then.

While a spurt of yuan appreciation usually precedes Sino-American talks (there is a round due in Washington mid-May), the People’s Bank of China seems now to be  belatedly letting the yuan shoulder more of the burden of fighting inflation, by making energy and food imports cheaper. The currency has gained almost a full percentage point against the dollar this month, as much as it was allowed in the whole first quarter. Since Beijing freed the yuan from its dollar peg in 2005, with a near two-year repegging after the global financial crisis hit in 2008, the yuan has gained 27.5% against the dollar under the central bank’s managed appreciation regime. Since it was unpegged for a second time in June 2010 the yuan has appreciated 4.6% against the dollar, though it has depreciated in nominal effective terms.

As the chart below, from the World Bank, shows, the yuan’ effect exchange rate has been trending up if not by as much as the nominal figures for its appreciation against the dollar might have one imagine. REER stands for real (i.e. inflation-adjusted) effective exchange rate (the value against a trade-weighted basket of currencies),  NEER for nominal effective exchange rate. Note the widening gap between the two since mid-2010 during which time exports have been resurgent.

The question for investors now is whether April’s appreciation against the dollar signals a willingness on the central bank’s part to step up the pace of appreciation of the currency in the face of stubbornly high inflation, or, as we suspect, just that it plans to continue to let the yuan rise as it has been doing.

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