Tag Archives: SDR

The Renminbi Ups Its Status

100 yuan notes

THE INTERNATIONAL MONETARY Fund added the renminbi to its basket of Special Drawing Rights (SDR) currencies at the start of this month, thus officially marking it as a member of the elite club of global reserve currencies. It is a membership of which China has long been desirous.

The IMF had decided last November that China could join at the next scheduled SDR review, and that it would constitute 11% of the basket. That gives it the third largest share, behind the dollar and the euro but ahead of the other member currencies, the yen and sterling.

Weightings are meant to reflect the use of a currency in trade and the financial system so China may have been treated generously in this regard. It share of global payments, for example, peaked at 2.8% last year and is below 2% now.

Joining the SDR basket is, at this point at least, as much symbolic as anything, an acknowledgement of the global weight of China’s economy, and encouragement to push ahead with the financial reforms that would make the renminbi the freely usable and widely adopted currency that IMF reserve currencies are meant to be.

That, in turn, would promote more foreign interest in yuan-denominated assets, particularly bonds. Central banks and sovereign wealth funds will, however, build up their renminbi-denominated holdings only gradually.

Looking back in a decades time, though, the change may look more momentous, both if China’s financial markets become deeper and more liquid or it turns out that the renminbi was just the first of several emerging market currencies (India’ rupee is another candidate) to find a place in the SDR basket.

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SDRs And The Yuan’s Status As A Global Currency

100 yuan notesMILESTONES ARE IMPORTANT markers. Case in point: the International Monetary Fund is likely to include the yuan in its currencies basket when it reviews the components of its Special Drawing Rights (SDRs) later this year.

The IMF’s determination in May that the Chinese currency is fairly valued was a straw in the wind. The Fund’s position stands in contrast with much opinion in the United States that Beijing manipulates the exchange rate to favour China’s exporters.

Once that may have been true, but no longer in any more than the most tangential way. Beijing has allowed the currency to appreciate for the past decade to get it close to ‘fair value’ through small but regular increments constrained by a daily trading band. The yuan has risen by some 25% over that time against the dollar.

That appreciation is the precursor to what may prove to be the most significant event in foreign exchange markets since the introduction of the euro. Beijing has been steadily but cautiously moving towards making its currency freely convertible and carefully opening up its capital account to that end.

That policy is also an important component of the broader policy priority of rebalancing of the economy. The yuan is now the world’s fifth most used currency, but still has a lot of ground to make up on the dollar and the euro.

To an extent, ‘internationalising’ the yuan is a potent way for China’s leaders to reflect the country’s growing power onto one of the biggest global financial markets and in doing so challenge the dollar. But it is also an inevitable consequence of the greater integration of China’s economy with the global economy.

The course of that consequence is clear: from paying for goods and services; to being a currency for global investment; and finally, the ultimate accolade, becoming a ‘reserve’ currency. 

Last year, more than 20% of China’s trade, or 6.5 trillion yuan, was settled in China’s currency. The forecast is that that proportion will pass one-half by the end of this decade. The yuan is now the world’s fifth most used currency behind the yen, pound, euro and dollar, up from 20th-most used as recently as 2011.

However, as an indication of how much ground the yuan still has to catch up, it accounts for 2% of global payments. The dollar accounts for 45% and the euro 28%. Closing those gaps will require a significant change to commodities pricing. The dollar rules that roost, especially energy contracts.

Offshore RMB clearing banks — they now exist in Canada, Qatar and Chile among half a dozen countries plus Hong Kong — are a key step in encouraging investment in yuan and greater use in trade finance. The RMB clearing banks increase pools of offshore liquidity that in turn encourage the creation of investment products.

The One Belt One Road initiative will similar boost yuan usage. The yuan-denominated loans that Beijing is making to support this infrastructure framework of overland and maritime connections to Europe will find their way back to Chinese suppliers of construction, engineering and financial goods and services. The process will repeat for providers of other goods and services such as logistics, insurance and finance as trade multiples along the new routes.

This development will mirror on a larger scale what is already happening with outward Chinese foreign direct investment, about one-third of which is now yuan-denominated.  Free-trade zones in Guangdong, Fujian and Tianjin, modeled on the one in Shanghai, will further boost this. Bit by bit, cross-border use of the yuan is being built up.

In the wake of the 2008 global financial crisis, Beijing put in place currency swaps with more than 30 other countries to ensure a rapid freezing of dollar credit markets would not again hurt its exporters. Though these, thankfully, have not been much used, they have symbolic importance for Beijing’s push to promote the yuan’s greater use in trade finance.

Just as symbolic has been the increasing willingness of other countries to start including the yuan in their official foreign-exchange reserves. The People’s Bank of China estimated that foreign central banks held about two-thirds of a trillion yuan in their official reserves at the end of April. That sounds a decent chunk of change.

However, it would be less than 2% of the total, according to this Bystander’s back-of-an-envelope calculation. That compares to 4% for the pound sterling and 23% for the euro while the dollar’s share tops 60%. It will be decades before the yuan catches even the euro.

Yuan bank deposits outside mainland China have doubled since 2013 to some 2 trillion yuan — half of them in Hong Kong. A large part of the overall increase has been speculative money riding the currency’s appreciation. That play is over, crimping the growth in deposits. However, even 2 trillion yuan is a rounding error in the global total of bank deposits.

Investors also now have a growing range of yuan-denominated instruments beyond bank deposits from which to choose. Increasingly this includes domestic bonds and equities, not just offshore ‘dim-sum’ bonds. The pilot cross-trading of Shanghai and Hong Kong equity issues, which is all yuan-denominated, has been a boom in this regard. It will continue to expand, and Shenzhen stocks are expected to join the arrangement before too long.

The concept is being applied to mutual funds, too, again initially on a trial basis. At the same time, opportunities for Chinese investors to invest directly in overseas financial markets are gradually being expanded through the qualified investors scheme.

On some calculations, China is now a net exporter of capital.

For all the aspirations of Beijing and the real progress the yuan has made towards becoming a global currency, there is still an awfully long way to go. If the IMF does include the yuan in its SDR basket, as Beijing is lobbying for so hard if so discreetly, it will nudge the Chinese currency a little further down that road, but only a little bit.

A bigger question is, how much impact such a high-profile move would have on American companies that, as a class, do not conduct international trade in any currency other than their own, let alone China’s. In a U.S. presidential election season, when some candidates will want to be seen to be ‘tough on China’, it could prompt a backlash if the debate becomes a xenophobic ’the dollar vs. the yuan’.

A further, if less likely political risk, is that the U.S. uses its veto to block a decision to include the yuan in the SDR basket. That would be a confrontational move, far beyond Washington’s passive but notable absence from any support for any of the moves Beijing has made to expand the international use of the yuan.

Beijing has made a commitment to liberalise fully its capital account by the end of this year, and thus, to all intents and purposes, to the yuan being fully convertible. The economic reformers see that as a stepping stone to further opening of China’s domestic markets to foreign capital that will be necessary for overall economic rebalancing. There are vested interests that oppose full convertibility for just that reason.

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Zhou Bangs On About The SDR As World Currency

The People’s Bank of China has found a drum and continues to beat it. In its annual financial stability report, the central bank again calls for a super-sovereign currency to replace the dollar. The bank’s head, Zhou Xiaochuan, has been a cheerleader for this course of action, and caused a stir earlier this year when he said the dollar could eventually be replaced as the world’s main reserve currency. As well as using the SDR in that role, the PBOC report recommends that the International Monetary Fund  manage a portion of its member countries’  foreign reserves.

We heard a similar thumpty-tee-thump ahead of the BRICs summit in Yekaterinburg earlier this month, though in the event not much policy to that end. China feels acutely the weak dollar’s diminishing of its large and largely dollar-denominated foreign exchange reserves (though it would face a similar problem under an SDR regime if it continued to run huge surpluses). However, the  PBOC has the luxury of seeing the policy remedy to its current dollar bugbear through a purely economic lens, without the realpolitik filter the top Party leadership must employ. (Yves Smith has more detailed discussion of the economics at Naked Capitalism).

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