(Yicai) June 18 -- Adopting a “barbell strategy” built on two pillars, namely a low-interest-rate financing currency and a strong investment currency, could enhance the Chinese yuan’s international roles in financing and investment amid a changing global environment. This approach would help create a positive cycle in which financing promotes yuan usage while investment expands its global influence, further improving the redback’s international circulation.

In the international financial system, different sovereign currencies play different roles in global capital flows, mainly as financing currencies or investment currencies.

Generally, a financing currency is characterized by low interest rates and a relatively stable exchange rate. It is commonly used for cross-border financing and arbitrage transactions, serving as a source of funding in international capital markets.

An investment currency, by contrast, functions mainly as an asset-allocation vehicle. Its attractiveness comes from the investment returns offered by assets denominated in that currency and from potential currency appreciation. It is mainly used to meet global capital allocation needs.

Two Pillars

There are currently two typical models for the internationalization of the yuan. One is the low-interest financing currency model similar to the Japanese yen, which relies on low borrowing costs and a stable exchange rate to provide financing sources for international capital.

The other is the high-interest investment currency model similar to the US dollar, which relies on strong financial markets and high-quality assets to attract global capital.

Although these two models can conflict in terms of interest rates and exchange rates, they are not mutually exclusive. The relative performance of the redback and the dollar provides a buffer for potential conflicts between investment and financing currencies.

Yuan Financing

In recent years, geopolitical risks have increased and the global environment has become more complex. However, China’s foreign trade has remained strong and resilient. At the same time, Chinese companies have continued to expand overseas.

Driven by both trade growth and outbound investment, Chinese firms are operating in a wider range of markets and with greater international depth. As a result, demand for offshore financial services has increased significantly.

At present, yuan financing offers a cost advantage. From an interest-rate perspective, China maintains a moderately loose monetary policy, and yuan financing costs are expected to remain low. From a global perspective, geopolitical tensions may further amplify the cost advantage of the yuan as a financing currency.

Therefore, China should take advantage of the current favorable environment for the redback’s financing role. Instead of relying mainly on domestic participants, China should allow more foreign entities to use yuan financing.

This process should be gradual. For example, China could first open access to countries and regions that have strong trade links with China and which already use the yuan to some extent. Financing should be directed mainly toward trade and investment activities. This would help promote yuan internationalization while preventing possible credit risks caused by bond defaults and exchange-rate volatility risks caused by excessive arbitrage activities.

Appreciation Potential

Low-interest-rate currencies often face depreciation pressure. However, in practice, exchange rates are influenced by many factors. The potential for medium-to-long-term appreciation of the yuan continues to grow.

On this basis, China can pursue a “strong currency” strategy, allowing the yuan to appreciate steadily under healthy economic conditions and promoting the redback’s role as an international reserve currency.

From an external perspective, the large-scale issuance of US treasury bonds has significantly weakened confidence in the dollar. In this environment, the yuan may appreciate against the greenback as a result of dollar weakness.

From a domestic perspective, China’s technological capabilities are developing rapidly and labor productivity continues to rise. The country’s export structure is becoming increasingly similar to that of developed economies, and its international competitiveness continues to improve. These factors provide a long-term economic foundation for yuan appreciation.

Historical experience shows that currency appreciation is often accompanied by rising labor productivity. From the perspective of purchasing power parity, the yuan also appears to have significant room for appreciation over the medium to long term.

Strengthening Stability

Going forward, China still needs to further strengthen yuan stability by improving the competitiveness of its financial markets, building solid national creditworthiness, and implementing reasonable foreign-exchange management policies.

To support yuan internationalization, China must continue improving its financial soft power. First, it should further improve financial infrastructure. Second, it should strengthen cross-border legal and regulatory frameworks. Third, it should deepen the offshore yuan market.

By increasing cooperation between Shanghai and Hong Kong as financial centers, China can enhance Shanghai’s role in global capital allocation, build an offshore financial system that matches Shanghai’s status as an international financial center, expand Hong Kong’s offshore yuan liquidity pool and develop a broader range of yuan-denominated financial products.

At the same time, accelerating fiscal and tax reforms and maintaining balanced government finances are important for preserving national creditworthiness and currency stability. Ultimately, the true foundation of a fiat currency is the credibility of the issuing government. In addition, China should adopt more reasonable foreign-exchange management strategies.

The authors are Sheng Songcheng, dean of the China Chief Economist Forum’s research institute and senior academic advisor at the CEIBS Lujiazui International Institute of Finance, Zhuang Hongyu, a researcher at Guolian Fund, and Long Yu, a researcher at the CEIBS Lujiazui International Institute of Finance.