China has helped globalize the yuan by gradually opening up its bond market to foreign investors, a new paper says.
Chinese bonds are now treated more like debt from a developed nation, rather than from an emerging market, the authors argue.
But Beijing faces a big test as China’s bond market has seen record outflows.

China’s gradual opening of its bond market has helped elevate the yuan’s status globally, but the currency is about to face a big test.

Over the last two decades, China has gradually allowed more traders and central banks to buy into its yuan-denominated bond market, according to an August paper published by the National Bureau of Economic Research.

Beijing staggered the entry of stable investors into its debt with a series of policy moves that included varying quotas, lock-up periods, and registration requirements. Now, Chinese bonds are viewed more favorably, are starting to be treated more like debt from more advanced economist, the economists wrote.

“We find that China’s reputation is in between emerging markets and developed countries and has drifted upwards in recent years,” they said.

While the yuan still has a long way to go before it can challenge the US dollar on the world stage, China’s currency is becoming more international, the paper added.

Indeed, Russia’s war on Ukraine and the Western sanctions that followed have spurred greater use of the yuan. Russia is now the third-largest market for yuan transactions outside the Chinese mainland, as it takes payment for its energy exports in yuan instead of the dollar, which is the primary currency for most commodities.

For now, the yuan is the fifth most widely used currency in international payments markets, according to SWIFT data. The US dollar remains at the top, followed by the euro, British pound and Japanese yen.

But in recent months, China’s currency has been losing value as central banks around the world hike interest rakes while the People’s Bank of China cuts rates. On Friday, the yuan dropped to its lowest level in three months.

The decline has coincided with a record outflow from China’s bond market, presenting a major test for Beijing, which could be tempted to restrict capital to stop the bleeding.

Ultimately, the authors wrote, the trajectory for yuan-denominated bonds will not be a straight line as China’s reputation will fluctuate based on any restrictions on foreign investment in the face of future crises.

“By beginning with allowing investment from more stable investors and only later allowing in flightier ones, China has put itself on a path towards becoming an international currency while trying to minimize the risks it faces on the transition path,” the paper said. “Whether it is able to achieve this while avoiding costly episodes of capital flight and the imposition of capital outflow controls is an open question.”

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