The International Monetary Fund will hold discussions in May and make a decision in November on whether to add the Chinese renminbi to the four currencies it uses to value its Special Drawing Right (SDR), the international reserve asset created by the Fund.
China is keen for this to happen, as the deputy governor of its central bank, the People’s Bank of China (PBoC), reiterated at a press conference in Beijing on Thursday. There is a snag: the renminbi is not and may never be a convertible currency, which is a standard pre-requisite of a reserve currency. But as David Lubin of Citi Research argues in a note also published on Thursday, that consideration is likely to be put aside.
China’s share of global exports has continued to grow since it overtook the US as the world’s biggest exporter in 2007. The renminbi is used to settle almost a quarter of China’s current account transactions.
To be sure, in terms of world payments processed by SWIFT, the renminbi is still tiny compared with the US dollar, the euro and even sterling. But it is not much smaller than the yen and recently overtook the Canadian dollar to become the fifth most used currency. Also, even if by a wide margin, it is the second most used currency in trade finance.
So China has already made great strides in its ambition to make the renminbi an international currency. It is no small ambition. Success would not only reduce funding costs for Chinese companies and help them expand overseas; it would also support the creation of a Sino-centric financial order to challenge the western-dominated Breton Woods institutions set up after World War II.
How would inclusion in the SDR basket advance China’s progress to its goal? As Lubin notes, adding the renminbi to the dollar, euro, yen and sterling in the SDR basket would not put any obligation on central banks actually to hold renminbi among their reserves, although it would give any bank holding SDRs an implicit exposure to the renminbi.
Significantly, however, inclusion in the SDR basket would allow the renminbi to sidestep the convertibility criterion for a reserve currency. As Lubin notes, IMF rules state that “reserve assets must be denominated and settled in convertible foreign currencies…” Under that rule, central banks that currently hold renminbi cannot report them as part of their foreign reserves. But if the renminbi joined the SDR basket, it would automatically and by definition become a reserve currency – in all likelihood, Lubin reckons, precipitating a change in the IMF’s rules.
If so, central banks would be free to hold renminbi as part of their reserves. This would mark a huge step forward for China’s strategic aims. Rubin writes:
Creating RMB liabilities is really the only way in which China can advance its goal of internationalising its currency, and the persistence of China’s trade surplus means that it is difficult to create net RMB liabilities through the current account of the balance of payments. As a result, China needs to rely on capital transactions to achieve its goal, and inclusion in the SDR basket is an important way of achieving this…
Of greater significance, however, is the change implied in the global financial order were the renminbi to join the SDR basket. Lubin quotes a well-known speech of 2009 by the governor of the PBoC arguing that the SDR should become the centre of gravity of the international monetary order, functioning as a “super-sovereign reserve currency” that would be “disconnected from economic conditions and sovereign interests of any single country”. China, then, would share a central role in a system hitherto dominated overwhelmingly by the US dollar.
What are the renminbi’s chances of inclusion? The IMF, Lubin notes, has two criteria: a country’s share in global exports; and whether its currency is “freely usable”.
As shown above, the renminbi meets the first of those conditions by a wide margin. The second condition – the IMF’s own rules notwithstanding – is not the same as being “freely convertible”. One of the tests to determine whether a currency is freely usable, Lubin notes, is whether it is “widely traded”. Here, too, the rebminbi appears to qualify. What’s more, Lubin writes, “the IMF makes it clear that the decision to include the RMB in the SDR is not a box-ticking exercise: judgment will be required.”
As Simon Mundy reported for the FT, also on Thursday, Samsung Electronics has outlined plans to start trading renminbi in South Korea, in a bid to cash in on China’s drive for internationalisation. The renminbi’s long march is looking unstoppable.
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