On Monday, November 30, the International Monetary Fund, or IMF, announced that the Chinese yuan would officially be included as a global reserve currency. The development will take effect on October 1, 2016. This was a landmark step as there have only been four reserve currencies thus far: the U.S. dollar, the Japanese yen, the euro, and the British pound.
The news is sure to have significant ramifications for China and its economy. This article will discuss the effects of the Chinese yuan gaining acceptance as an elite currency, and the exchange-traded funds that may benefit from exposure to Chinese equities.
Reversing Policy Course
In recent years, China has taken aggressive steps toward monetary easing. China’s central bank, the People’s Bank of China, cut interest rates in October for the sixth time in the past year. In addition, the central bank reduced the level of reserves that banks must hold. These actions were designed to devalue China’s currency, thus making its exports more competitive, boosting that nation’s economy.
However, the news that the renminbi will be accepted as a reserve currency by the IMF signals a change in policy. By earning reserve status, China is essentially loosening its grip over its own currency. Going forward, China will have to give up the tight control it has had over its currency in recent years. As a global reserve currency, it is likely that China will see increased demand for the renminbi now that it will play a role in international finance. Greater demand should result in an increase in the value of the renminbi.
What's the Effect on the Chinese Economy?
If the Chinese renminbi indeed gains value against other global currencies, it will affect the Chinese economy in a number of ways. Primarily, exports are likely to become less competitive on the global stage, as typically happens when a currency strengthens. That is because goods purchased outside of China will be cheaper than goods manufactured in China.
However, there will be a positive effect as well. Specifically, a stronger currency is typically viewed as a sign of a strong economy. While exports will become less competitive, the Chinese consumer stands to benefit from a stronger Chinese economy. China is one of the premier emerging markets. It has a population that exceeds 1 billion and tens of millions of consumers will be elevated into the middle class with a stronger Chinese economy. This will result in a booming consumer class in China. Companies that cater to the Chinese consumer will likely see a meaningful improvement in business conditions.
ETFs With China Exposure
China’s currency gaining recognition as a global reserve currency is a positive development for the Chinese economy. Chinese equities stand to benefit as well. As a result, here are a few ETFs with heavy Chinese equity exposure.
- First Trust China AlphaDEX ETF (FCA ) holds 100% Hong Kong and Chinese equities. The fund has a 0.8% annual expense ratio. Among the fund’s top 10 holdings are Evergrande Real Estate, Metallurgical Corp. of China, and Dongfeng Motor Corp. The fund has lost over 2% of its value this year.
- Global X China Consumer ETF (CHIQ ) comprises 99% Chinese equities. This fund predominantly focuses on the consumer discretionary sector and could be an optimal play on the booming Chinese middle class. Some of its top holdings include Ctrip.com International, Alibaba Group, and JD.com.
- iShares China Large-Cap (FXI ) also comprises 99% of Chinese equities. This ETF caters to more risk-averse investors because it holds specifically large-cap equities. Large-caps are companies with market capitalizations in excess of $10 billion. These are generally more stable companies than small-caps, with larger operations and more reliable profits. This ETF provides the added advantage of offering a 2% yield. Large-caps are more frequent dividend-payers than small-caps.
- Guggenheim China Technology ETF (CQQQ ) holds 99% Chinese equities. It invests primarily in equities in the technology sector, and would be a particularly interesting play on Chinese technology firms. Among its top holdings are Tencent Holdings, NetEase, Lenovo Group, and Qihoo. It offers a 1% dividend yield and has returned 2% year-to-date.
For more ETFs, please check out our China exposure ETF list.
The Bottom Line
The announcement that the Chinese renminbi will be accepted as a global reserve currency is huge news for the Chinese economy. Going forward, China will be officially recognized as a global superpower. Its currency will become more highly utilized in international financing, and many economists believe this will be a long-term boost to the country. The ETFs listedabove have high allocations to Chinese equities and could generate satisfactory returns.
