Too Quick to Exaggerate SWIFT Data

The media pounced on a report from SWIFT, the international messaging platform for financial transactions, which showed a rise in the use of the Chinese yuan to record levels.  According to SWIFT, the use of the yuan surpassed the Australian and Canadian dollar to move into fifth place.  

It is not that there is a reason to doubt the validity of the SWIFT data.  The point is that it is being exaggerated.  First, the yuan's share is only 2.17% of global payments by value.  Yes, it has increased from the 1.59% share in October.  However, to regard it as a 36% increase is misleading.  

Several press reports tried linking the increased use in the yuan as a potential precursor to a decision later this year by the IMF. The IMF is scheduled to review the Special Draw Rights (SDRs), which is a basket of currency (composed the dollar, euro, sterling, and yen) that is used to settled inter-government obligations.  

The fact of the matter is that in terms of international use China still punches below its weight.  It is the world's largest exporter.  It is among the largest importers. Yet the yuan's share of global settlement remains minor.  

The yuan is not freely convertible.  This was the main reason cited by MSCI last year when it declined to incorporate A-shares (that trade on the mainland) as part of its global indices.  

In addition, there is another source of exaggeration that is widespread and largely undetected. It involves Hong Kong.  It is either a part of China or it is not.  If it is part of China, the fact that China and Hong Kong transactions boost SWIFT figures it not really a sign of the internationalization of the yuan.  It is the distorted side-effect of having one country with two currencies.  

The same criticism applies to China's claim that a quarter of all its cross-border payments in 2014 were conducted in yuan.  Hong Kong receives nearly a fifth of what are called Chinese exports.  That is another gross distortion of the internationalization of the yuan.  While, of course, there has been some increased use of the yuan, there has also been what we called the Sino-ification of Hong Kong. If China's commercial relationship with Hong Kong would be regarded as an internal and domestic affair (which is how Chinese officials wanted to view the Occupy Central movement), then the SWIFT figures would also look quite different. 

Lost in the discussion about the mercurial rise of the yuan is the fact that the global payments system is highly concentrated.  The dollar (44.6%) and the euro (28.3%) account for almost 3/4 of global payments.  Sterling is in a distant third with 7.9% share.  The yen is fourth at 2.69%.    

SWIFT figures are based on value and shifts in currency values need to be taken into account, though it is noticeably absent from the media reports I read.  Those reports all highlight that the yuan moved ahead of the Canadian dollar and Australian dollar, and could surpass the yen's share.  In Q4 14, the Canadian dollar declined 3.6% against the US dollar.  The Australian dollar fell 6.5%. The yen fell 8.5%.  The yuan lost a little more than 1% against the US dollar.  

China has granted 10 countries the privilege of clearing yuan trades.  This is only significant because the yuan is still not freely traded.  China doles out the privilege and observers trip over themselves to celebrate the internationalization of the yuan.  A little more than two dozen central banks have currency swap lines with the People's Bank of China.  Yet they remain mostly dormant. After big currency swings, such as the marked appreciation of the Swiss franc and the dramatic depreciation of the Russian ruble, the precise size and conditions of those respective swap lines may be somewhat less clear now.   

It is not immediately clear how many central banks have yuan-denominated assets are part of their reserves.  Some estimates put the number as high as 50.  If it is truly that high (nearly one in four countries) we suspect the actual value is relatively modest.  It would currently be picked up in the "other" category the IMF uses for its COFER data.  Since China accounts for the vast majority of the unallocated reserves, we should look at the allocated reserves to estimate the yuan's share.   

The most recent COFER data covered Q3 14.  It showed the "other " category was about $196.6 bln. This would also include other currencies such as the Singapore dollar, South Korean won, as well as the Swedish krona and Norwegian krone.    Recall that global reserves stood at $11.78 trillion at the end of Q3.  

There is no compelling reason the US and Europe should agree at this juncture to include the yuan in IMF's money SDRs.  If China desires to be included, which is not immediately obvious, there are concessions that could be demanded, such as opening up its capital account and letting the market forces more directly drive the yuan's exchange rate.  

China's interest rates are high, especially compared with the euro area and Japan.  Between the eurozone and Japan, more than $3 trillion of bonds offer negative yields.  However, the yuan is not in an appreciation mode.  Ironically, if anything, the PBOC is moderating its decline.  Last Friday January 23 and Monday, January 26, the yuan recorded its biggest two-day decline in nearly seven years.  China appears to be experiencing net capital outflows, not inflows as was previously the case. 

There is another SWIFT story that may have been eclipsed by the focus on the yuan’s 2.17% share of global payments.  Recall that SWIFT is overseen by the G10 central banks and the ECB.  It has in the past complied with formal sanctions.  For example, it has not allowed Iran to participate in the payments/messaging system. 

Given the increased tensions with Russia over Ukraine, the US and Europe are considering more sanctions against Russia.  Last September, the European Parliament urged countries to consider excluding Russia from the SWIFT system.  At the time, the Russian minister of economic development said such a move was unlikely.   He was right, but the issue has not gone away.  Earlier this week Prime Minister Medvedev threatened an “unlimited” response if Russia were to be excluded from SWIFT. 

Nothing appears to have come from the earlier Russian threat to develop a parallel system to SWIFT.   The international payment system is a public good in a similar way that dollar and euro funding is a public good.  As part of the sanction regime, Russian banks and companies have been denied access to these public goods.  It may still be early to expect Russia to be barred from the SWIFT system.  However, as financial channels are brought to bear, this cannot be ruled out indefinitely, especially if the confrontation escalates.