The worth of the Chinese yuan is decreasing, but its reach is expanding

Foreign investment has been a major contributor to China's growth. Prior to Foxconn's involvement with Apple, manufacturers from Hong Kong ventured into Guangdong in pursuit of inexpensive labor. Sarah Monks, author of the book "Toy Town," mentions the story of Jetta, a toymaker, opening a spray-painting plant near some lychee orchards in Dongguan in 1982. Necessities such as a shower were made available by boiling water in a wok and the plant was situated in a tin shack. Ms Monks also mentions that employees at another firm determined that Mickey Mouse's nose should be colored red, and not black.

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 At the close of 2019, the level of direct investment in China was over $3.5trn. However, unexpectedly, in the third quarter of 2020 something noteworthy occurred; for the first time since records began in 1998, the flow of fdi was in reverse, with foreign investors withdrawing more funds than they invested, resulting from repatriated earnings, repaid intra-company credits, and the disposal of assets. (See Chart 1)

 The change in sentiment may be due to foreign doubts regarding the economy and decision-making of China. It is probably going to hit its growth goal of 5% for 2020, yet it could still shrink in terms of dollar value, as indicated by the International Monetary Fund's recent predictions. The stringent measures taken by the Chinese government in light of COVID-19, the regulatory clampdown on technology firms, and the inspection of foreign due-diligence companies, such as Bain, Capvision, and Mintz have made investors uneasy.

 The intensifying geopolitical competition has made it more difficult for foreign investors to discover opportunities that are both financially appealing and acceptable politically in both their native and host countries. According to a March survey from the American Chamber of Commerce in China, 24% of members were considering or had already started relocating their manufacturing out of China, an increase from the 14% reported the year before.

 In the third quarter, a potential cause of the sudden shift may be attributed to a technical reason. With interest rates being higher in the US than in China, businesses have an incentive to take their excess funds outside of the nation and settle any debts to their subsidiaries with Chinese financing. According to Julian Evans-Pritchard from Capital Economics, a research firm, "the majority of companies can borrow at a lower price in China and almost all of them can make a better return on the financial resources they move out of the country."

 The interest-rate discrepancy and geopolitical divide has had a negative effect on one type of globalisation. Nevertheless, it could be aiding a different kind: the acceptance of China's currency, the yuan, which is frequently referred to as the "redback" overseas.

 The Chinese central bank reported in the past month that the cost of borrowing in the yuan had gone down compared to other major economies. This has led to 106 billion yuan ($15 billion) of Panda bonds being issued in China by foreign companies in the eight months leading up to the present day, which is a growth of 58% from the same time in 2022. In addition, September saw the yuan surpass the euro to become the second-most-used currency for trade financing, with 6% of lending, according to Swift, a company that provides payment messaging services.

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 A thorough new investigation by AidData from William and Mary, an American university, has revealed how state-owned creditors have implemented a "strategic shift" away from the use of the US dollar in lending to lower and middle-income countries (observe chart 2). The share of fresh commitments in Chinese yuan skyrocketed from 6% in 2013 to 50% in 2021.

 The Chinese central bank has loaned out many of these funds to nations with considerable debt. The intended consequence of doing this was that it enabled the recipients to pay off Chinese creditors and the International Monetary Fund with yuan, thereby preserving their limited dollar reserves for other essential needs. The researchers of the AidData report pondered if this could have been a deliberate move from China's leaders to "kill two birds with one stone"--avoiding defaulting and simultaneously promoting the international utilization of the yuan.

 Saleem Bahaj of University College London and Ricardo Reis of the London School of Economics have concluded that nations that borrow in the yuan are more likely to make use of it for international transactions. Forty countries have thus far reached a swap agreement with China's central bank, which requires them to exchange yuan for an equal amount of the other party's currency. Their research has revealed that signing such an agreement increases a country's international payments in terms of yuan by 1.3 percentage points.

 The effects of the sanctions enforced by the US and Europe have had a positive impact on the yuan. According to Evans-Pritchard, more than half of China's transactions with foreign nations have been paid in their own currency. Guangdong alone has a higher percentage of 54% during the first three quarters of this year. Even though it was unable to get Mickey to wear a red nose, it was able to get some foreigners to accept the redback.