China’s gradual opening of its bond market has aided the yuan’s global standing, but the currency is about to face a major test.
According to a National Bureau of Economic Research paper published in August, China has gradually allowed more traders and central banks to buy into its yuan-denominated bond market over the last two decades.
With a series of policy moves that included varying quotas, lock-up periods, and registration requirements, Beijing staggered the entry of stable investors into its debt. Chinese bonds are now being treated more favourably, with more advanced economists treating them more like debt, the economists wrote.
“We find that China’s reputation is somewhere between emerging markets and developed countries, and it has risen in recent years,” they wrote
“We find that China’s reputation is somewhere between emerging markets and developed countries, and it has risen in recent years,” they wrote.
However, China’s currency has been losing value in recent months as central banks around the world raise interest rates while the People’s Bank of China cuts rates. The yuan fell to its lowest level in three months on Friday.
The drop has coincided with a record outflow from China’s bond market, posing a significant challenge for Beijing, which may be tempted to restrict capital to stem the bleeding.
Finally, the authors wrote, the trajectory for yuan-denominated bonds will be a zigzag because China’s reputation will fluctuate depending on any restrictions on foreign investment in the face of future crises.
“By first allowing investment from more stable investors and then allowing in flightier ones,” the paper said, “China has put itself on a path towards becoming an international currency while attempting to minimise the risks it faces on the transition path.” “Whether it can do so while avoiding costly episodes of capital flight and the imposition of capital outflow controls remains to be seen.”
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