Investing in Chinese yuan

Investing in Chinese yuan

The International Monetary Fund recently decided to include the Chinese yuan in its Special Drawing Rights (SDR) basket as a fifth currency, along with the United States dollar, euro, Japanese yen and pound sterling.

The currency will become part of the basket in October this year, a move that will further integrate China into the global economy, while at the same time promoting the internationalisation of the yuan.

Little more than a decade ago, the yuan was a currency for specialists, the kind of thing that interested economists and bankers. Even professional currency traders took little notice of it, as strict government controls meant that it was hard to find outside of China, while a peg against the US dollar kept the yuan stable, making it an unattractive trade.

The situation is very different now, as Beijing has made significant progress in realising its goal to make the yuan a major international currency. It is already the world's fifth most active currency used in global payments, overtaking the yen, according to Swift international payment network, and the yuan is now widely available across the world.

In fact, the increased importance of the yuan has reached a point where retail investors can take advantage of a growing range of investment products that focus on the Chinese currency.

A few years ago, the most common method to profit from the yuan was to buy it with another currency, and hold it as it steadily appreciated in value. This was a particularly popular tactic in Hong Kong, with large numbers of people depositing the currency in their bank accounts, which contributed to the city becoming the first offshore yuan hub.

It was a strategy that worked well until early 2014, when the yuan appreciated to a record high against the dollar. Since then, concerns over a slowing Chinese economy have resulted in the weakening of the currency. In other words, investing in the yuan stopped being a one-way bet.

This was demonstrated most dramatically in August last year, when the People's Bank of China (PBoC) adjusted its daily yuan reference rate and allowed the market to play a bigger role in exchange rate determination. This announcement prompted the yuan's largest downward adjustment in 20 years.

The move by the central bank was unexpected, and generated plenty of press coverage that argued a substantial devaluation was about to take place. Many opined that this move was undertaken to make China's exports more competitive.

The reality is much more interesting. By loosening its grip on the yuan's exchange rate, the PBoC ushered in a new era where market participants will play a much larger role in determining the value of the currency. The currency has been relatively stable since August.

Retail investors need to consider a number of factors when looking at the yuan as a potential investment currency. On the one hand, they face a currency that is more subject to market forces. And at the same time, the range of investment products available to the retail investor is expanding as policy developments continue to unfold.

For those who already hold some yuan, the best option depends very much on one's individual financial needs and goals, as well as the duration of the investment.

Someone who is looking for potentially high returns can consider offshore yuan-denominated bonds, known as dim sum bonds; structured products that have yuan foreign exchange; or unit trusts that may use the yuan Qualified Foreign Institutional Investor scheme, a programme that allows offshore yuan funds to re-enter China and be invested in mainland securities.

Another option for people who can tolerate high levels of volatility is investing directly into China's domestic stock market, as the yuan-denominated shares have been available to overseas investors via the Shanghai-Hong Kong Stock Connect programme since late 2014.

Retail investors with a low risk threshold and a need to earn a fixed rate of interest can take advantage of yuan time deposits and structured deposits that aim to return principal upon maturity.

As China pushes ahead with the opening up of its capital markets to facilitate two-way flows, investors will gain greater access to its financial markets. The Mutual Recognition of Funds programme - a scheme that allows eligible publicly offered funds domiciled in mainland China and Hong Kong to be offered in both markets - is an important milestone in this respect.

The yuan's addition to the SDR, announced in November last year, will support confidence in the currency, which will thus encourage its use in trade and investment.

This serves as a sign of quality assurance for global users that the currency in question is very liquid and is stable as a store of value. It will also encourage China to stick to its reform agenda, which should result in more initiatives being announced in the coming months.

In October, Beijing unveiled a plan to achieve full convertibility within the Shanghai Free Trade Zone. The plan includes an individual cross-border scheme, the expansion of corporate and individual foreign currency conversion quotas, as well as additional measures to open up China's domestic capital markets to foreign investors.

These pilot programmes in the Shanghai Free Trade Zone should pave the way for nationwide implementation in the near future.

For people who do not yet have any yuan savings or investments, it is important to be clear about their specific needs, goals and investment horizons. As the yuan matures as an international currency, the decision to include yuan-denominated investments in one's portfolio will have to be made the same way as how one would assess or evaluate the role of other currencies in their investment plans.

It is important to bear in mind that the yuan's significance goes beyond its short-term exchange rate, as it is a currency that has already made its mark on the global investment landscape.

Thinking of the yuan in terms of China's integration in the global financial system and China's increasing influence as the second largest economy in the world, one can no longer stand by without considering the yuan's relevance to one's personal investment needs.

For those willing to participate in China's growth and the yuan's continued development, the currency will offer opportunities that will help them diversify their assets and grow their wealth in new ways.

The writer is head of retail banking and wealth management at HSBC Singapore.

This article was first published on Jan 3, 2016.
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