Foreign policy from the prism of currency

Live Mint, June 14, 2018

By Pradeep S Mehta

It is the season of high-profile conferences. At the IISS Shangri-La Dialogue held at Singapore recently, Prime Minister Narendra Modi outlined his vision for the Indo-Pacific region, extending from the shores of Africa to the Americas. Among other things, Modi noted that infrastructure projects must empower nations and should not place them under impossible debt burden. This was a veiled criticism of China’s debt diplomacy.

Despite the threat of difficult debt burdens, 14 countries of eastern and southern Africa joined a forum in Harare, Zimbabwe, to consider the use of China’s yuan as a reserve currency in the region. This was in recognition of the fact that most countries in the region have availed loans from China and it may make economic sense to repay them in yuan. Seventeen top central bankers and officials from 14 countries participated in the forum organized by the Macroeconomic and Financial Management Institute of Eastern and Southern Africa.

The difference in the foreign policy strategies of India and China is apparent. While the former is still articulating its vision, the latter is busy ruthlessly executing it.

Paying back in yuan
It would be folly to view the Harare meeting in isolation. It is a result of years of hard work and politicking by the Chinese government to present the yuan as a credible alternative to the US dollar. Not too long ago, in December 2015, the yuan was inducted as one of the currencies in which special drawing rights could be exercised—making it one of the most reliable currencies in the world. Since then, Ghana, South Africa, Zimbabwe and, most recently, Nigeria have entered into currency swap agreements with China to reduce reliance on the US dollar. After becoming the preferred trade partner for the African continent, China’s ambitions have expanded to operate the preferred reserve currency for nations in the region. This strategy could have significant consequences at a time when Africa is being touted as the “next factory of the world” after China, being developed through Chinese loans which are likely to be repaid in Chinese currency. To paraphrase a popular idiom, one may take manufacturing out of China, but one cannot take China out of manufacturing.

China paying for oil in yuan
Chinese yuan internationalization ambitions are not limited to Africa, and it is targeting the core of modern economy: oil. China recently began trading oil futures in its own currency and is planning to launch a pilot programme to pay for oil in yuan. Oil is the world’s most traded commodity, with an annual trade value of around $14 trillion, roughly equivalent to China’s gross domestic product.

Around 99% of crude trade happens in US dollars, giving the US government unparalleled leverage in geopolitics and geo-economics. China considers the push for the use of yuan for payment and settlement natural, given that it is the biggest buyer. Any shift in global trade towards the yuan will be a boon for China. Yuan-dominated oil contracts offer added advantages for Chinese companies looking for hedging opportunities, and onshore and offshore investors.

Stepping up at the right time
China has chosen the right time to step up its efforts to make the yuan a global currency. The world economy is retreating towards protectionism, with the influence of the US in global geopolitics gradually shrinking. The unpredictability of US President Donald Trump’s actions, which include isolating the country from the global trade order, is increasingly adding to dollar volatility and global woes.

China, understandably, intends to present itself as a stable and credible alternative to the US. However, it has been traditionally known to devalue its currency to boost its exports and economy. Global reliance on yuan is likely to boost its value, requiring the Chinese government to cede more power to market forces, something which may not be to its liking. For China, the path to make its currency global is laced with the challenge of making it flexible, broadening financial markets, and introducing necessary banking reforms. However, China is not one to be deterred.

Where does India stand?
India is likely to use a gradual approach in pursuit of internationalization of the rupee, despite increasing competition from the yuan. While India traditionally has had a head start compared to China in terms of rule of law, it has its own challenges in the areas of currency liberalization, exchange controls and rupee risk management, among others.

A National Institute of Public Finance and Policy paper, published in February 2018, throws cold water on any hopes of action by the Indian government on this front. It notes that the rupee currently accounts for approximately 1% of global foreign exchange turnover. It has a smaller market size across most trading instruments when compared to the top eight emerging-market currencies.

The “wait and watch” policy of the Indian government on this front reminds one of a similar broader foreign policy approach, which has resulted in an agonizing long wait for India to find its place in the emerging geo-economic and geo-political order and achieve its true potential. India needs to learn from its own and Chinese experiences, and consider rupee internationalization integral to foreign policy strategy before it’s too late.

Pradeep S. Mehta is secretary general of CUTS International.

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