China's yuan is propelling emerging currencies like never before

[HONG KONG] The Chinese yuan is having a greater impact on its emerging-market counterparts than ever before, and may play a crucial role in determining their performance in the coming year.

The currency's correlation with an MSCI index of its developing-nation peers rose to record in September on a weekly basis before edging back slightly amid the Omicron outbreak, Bloomberg data show.

While the close relationship is partly a result of China's large weighting, it has also been driven by the yuan's links to the Brazilian real reaching the strongest since at least 2008, and that with India's rupee touching a 3-year high.

The yuan's rising global influence is yet another sign of China's deepening connections across the world economy. Investors are increasingly being drawn to its bonds as an alternative to US Treasuries, while some banks are calling for the yuan to join the US dollar, euro and yen as a global reserve currency. Yet with China's potential being offset by murky policy making and regulatory crackdowns, being tied too closely to the yuan may also backfire.

"China is going to be a very important element of emerging-market stability and the growth picture," said Magdalena Polan, principal economist at PGIM in London. "The willingness for Chinese policymakers to stabilise growth will be very important to the outlook for Latam and Asia and South Africa, as countries there still rely quite a lot on exports from China."

The correlation between the yuan and its peers in the MSCI Emerging-Markets Currency Index climbed to 0.81 in September on a weekly basis from as low as 0.24 at the end of 2010, according to data compiled by Bloomberg. It was at 0.72 on Thursday (Dec 23). A reading of 1 would mean the assets moved in lockstep. That has traders of both emerging-market and G-10 currencies looking to the yuan for clues on where other pairs are headed.

While correlations can be measured in many ways, China's increasing presence in global trade has progressively boosted the yuan's links with those of its emerging-market peers. In 2000, the average developing nation sent only 2.2 per cent of its exports to China, while that proportion has now grown to 11.3 per cent, data from Societe Generale showed.

The investment bank says the yuan's relative stability has traditionally made it most closely correlated with those of its emerging-market peers with strong and credible policymakers such as Mexico, Chile and South Korea. Since the US-China trade war in 2018, however, the yuan's links with emerging markets as a whole have grown stronger, with the average correlation rising to 83 per cent that year, according to SocGen data.

The yuan's relative resilience this year has also played a role in limiting fluctuations across emerging markets, in what has otherwise been a very tumultuous 12 months. "The fact that the yuan's not doing too much, I categorise it as a volatility suppressant," said Paul Mackel, head of global foreign-exchange research at HSBC Holdings in Hong Kong. "We believe that stability can last for longer."

BLOOMBERG