China’s ambitions are increasingly global. We have seen China growing its influence in three main areas: its currency, its new development bank, and its outbound foreign direct investment. While China’s moves will affect developed countries, they have an outsized impact on frontier markets, and can be a catalyst for future growth in the younger economies of the world.
The Internationalization of the Yuan
China’s yuan is coming of age, and the Chinese government is pulling out all the stops to internationalize it and achieve their ultimate goal: to make the yuan an accepted world reserve currency. The most obvious evidence of this is their current campaign to have the yuan included in the IMF’s SDR basket. The SDR, which is re-weighted every 5 years, is used by central banks as an asset on their balance sheets. China’s yuan, which was non-deliverable in 2010 and therefore not included despite a strong push, is set to be included this year at a weighting greater than the British pound. This inclusion would allow central banks around the world to begin reporting the yuan on their balance sheets.
Even without SDR inclusion, the yuan’s stature in the global markets has increased rapidly over the past five years. There was the introduction of offshore, deliverable yuan (CNH) that started in Hong Kong and is now the most actively traded currency in Asia. From setting up domestic free-trade-zones, to creating more hubs for settling CNH worldwide, the yuan is set for the global stage.
But how does this affect frontier markets? There are two main ways.
First is through greater domestic currency stability for countries that have signed currency swap agreements with China. A total of 30 countries have RMB Bilateral Swap agreements in place with China, with Armenia the latest to sign one last week. Frontier markets that have an agreement in place include: Albania, Argentina, Armenia, Belarus, Kazakhstan, Mongolia, Nepal, Pakistan, Sri Lanka, the UAE, Ukraine, and Uzbekistan.
These swap agreements are like credit lines that give these countries’ central banks emergency liquidity in times of crises. Most importantly, China now has a history of valuing currency stability as seen in 2008 and in the recent USD rally; both times, China’s yuan was one of the best performing currencies in the world. This means that if another crisis hits, those countries will be able to access liquidity in a stable (perhaps even reserve-type) currency.
Second, China has not engaged in any talk of currency war and focused on stability, even as its main export competitors have all cut rates and been very accepting of domestic currency weakness. This is a boon to many frontier markets hoping to establish themselves as manufacturers and exporters.
The New Asian Infrastructure Investment Bank (AIIB)
There has been a lot written over the past month on how many countries have rallied to support the new China-led Asian Infrastructure Investment Bank (AIIB). Seen as a counter to the World Bank on a global stage and the Asian Development Bank within the region, the AIIB solidifies China as an infrastructure powerhouse on the world stage.
Infrastructure has long been China’s calling card, and most discussion of China’s impact on frontier markets draws on the work they have done in Africa. We won’t list all the projects they’re involved with, but China has been active even outside of Africa, with the recent bridge in Serbia a good example. A quick look at the Ongoing Projects page of the China Road and Bridge Corporation shows a wide range of different infrastructure projects all over the world.
With the introduction of the AIIB, more competition should lead to more funding and better terms for countries looking for finances, namely frontier markets. Some would say that the World Bank has been receding in importance recently, and even more would argue that their record in the past has been mixed at best. However, we still consider the creation of the AIIB to be positive for frontier markets.
China’s Growing Outbound FDI
A move towards a more deliverable currency is also a move towards a more open capital account. On the unofficial side, current restrictions in place have done little to stem the outwards flow of hot money. However, on the official side, China’s outbound FDI has grown steadily.
According to the latest data from China’s Ministry of Commerce, investment outflows hit $100 billion in 2013, growing 22.8% on the year. Not only was this the highest amount on record, but the outflow was not just to developed economies – investment in the EU was actually down 15.4%. In fact, “China’s investment in Latin America, Oceania, Africa and Asia grew up 132.7%, 51.6%, 33.9% and 16.7% respectively, and investment in North America saw a slight growth of 0.4% compared with that of last year.”
All this FDI is going into emerging and frontier market economies, with Latin America taking the lion’s share of the growth at the moment. Why Latin America? One guess is that it is political and a part of their ongoing dollar diplomacy policies, a topic we wrote about in 2012. The majority of countries still recognizing Taiwan are located in Latin America, and China has a history of trying to woo them to its side through investment. Given the close proximity to the US, it is interesting that Latin America has had the largest increase in investment and may be a sign for increased competition in the future.
One region that we would watch that is not specifically mentioned is Central Asia. As part of China’s ambitious Silk Road revitalization plan, Central Asia will play a huge role due mainly to their favourable location and historical involvement. You can learn more in a post we did earlier this year here.
China’s economic miracle has been staggering, and even though the headlines now have more to do with slowing GDP growth rates, there have been a lot of exciting developments lately. We do not think China overtakes the US as a world power, or that the USD will be replaced with the yuan. However, it is clear that China is looking outward more now, and that frontier markets could be the biggest beneficiaries.