But, while yuan strength is being driven by strong exports and the increasing productivity of China's economy, the appreciation is likely to be gradual given the currency's managed float, said Sheng Songcheng, Research President of China Chief Economist Forum and senior advisor of CEIBS Lujiazui Institute of International Finance.

At current levels around 6.80 to the dollar, the yuan remains significantly undervalued in purchasing power parity terms, and this is further exacerbated by Chinese inflation rates below those of other major economies, Sheng said, speaking after German Chancellor Friedrich Merz earlier in June called for international action to realign currencies.

While economists have noted that capital controls restrict the potential for the yuan as a major reserve currency, Sheng noted that China's low interest rates and the yuan's strength enhance its attractiveness for international financing and investment, which could help drive its international use. Yuan appreciation should not only make the currency more attractive to hold but also make it easier for authorities to ease capital controls, he said. (See MNI INTERVIEW: Yuan Use To As Much As Double)

Holding the yuan stable against a basket of other major currencies during periods of dollar weakness should also favour a greater international role, Sheng said.

DIM SUM, PANDA

Authorities are likely to further promote issuance of offshore Dim Sum bonds by both domestic and foreign entities, and encourage overseas institutions to issue onshore Pandas, said Sheng, a former head of the PBOC's statistics department. Russia's issuance of RMB bonds to facilitate trade settlement with China has increased the share of yuan in its foreign exchange reserves, he noted.

China needs to increase the supply of high-quality RMB assets, including regular issuance of RMB treasuries and central bank bills offshore, to deepen yuan pools and improve the offshore yield curve, Sheng said. Instruments such as RMB bond repos and derivatives should be expanded to provide liquidity and risk-hedging tools, he added. (See MNI INTERVIEW2: HK Bond Market Should Be Open To China Buyers).

It would be advisable for the PBOC to continue increasing the proportion of gold in its own reserves, Sheng said. While it should maintain a certain proportion in dollars, part of these could be transferred to big state-owned banks or state-owned companies, to flag the central bank's stance on promoting exchange rate flexibility, he said. 

Source | MNI

Author: Sheng Songcheng, Research President of China Chief Economist Forum and senior advisor of CEIBS Lujiazui Institute of International Finance