On November 14, 2012, the Chinese yuan traded at an all-time record exchange rate against the U.S. dollar.1 As investors continue to digest the impact of the U.S. elections, fears of the pending fiscal cliff and the recent transition in Chinese leadership, now could be a prudent time to reassess portfolio exposure to foreign currencies and to the world’s second-largest economy, China.

The leadership transition in China has refocused many investors’ attention not only on China but on emerging markets in general. Xi Jinping and Li Keqiang, the newly appointed Chinese party leader and premier, respectively, face the difficult task of continuing the transition from an export-driven, lower-middle-income economy to a consumer-based, high-income economy.2 Chinese policy makers have long embraced moderation and pragmatism in reforms, principles we are currently seeing in the Chinese currency market. However, as China continues its economic expansion (albeit at a slower pace than during the previous 30 years), several policy goals have been made abundantly clear.3 For Chinese policy makers, the next five years will be focused on:

1) Expanding economic prosperity more broadly
2) Avoiding a “middle income trap” through greater consumption and less reliance on exports
3) Expanding Chinese influence in the region4

Increasing the amount of trades settling in Chinese yuan is central to all three of these stated goals.

Given your investment positions in the Chinese currency, what does increased yuan trade settlement mean for your portfolio? The aim of increased trade settlement is to increase the use of Chinese yuan more broadly. A series of steps (including wider adoption for trade settlement; larger, more liquid financial products denominated in yuan; larger number of trading centers transacting in yuan) must gradually take place, but the groundwork for these developments is being laid now. The new Chinese premier has been a driving force behind the CNH (Chinese yuan in Hong Kong) initiative currently expanding to Taiwan and Singapore. In recent speeches, he signaled that China would continue to focus on initiatives to regionalize, and then internationalize, the Chinese yuan.

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