China may widen the trading band of the renminbi to boost its chances of inclusion in the Special Drawing Rights (SDR).
“One possibility that they could consider is band widening… if they want to show more flexibility in the currency,” said Adarsh Sinha, co-head of Asia rates and foreign exchange strategy of Bank of America Merrill Lynch.
The International Monetary Fund (IMF) will review the SDR currency basket in October.
“Our assessment is that inclusion of the renminbi in the SDR review is quite likely,” Sinha said.
Last year, the People’s Bank of China (PBoC) doubled the renminbi trading band to 2 percent, allowing it to fluctuate more widely from a daily reference rate against the US dollar.
The move allowed market forces to play a greater role in currency trading and ultimately in the wider economy.
SDR is a form of international reserve assets created by the IMF to boost global liquidity by supplementing standard reserve currencies.
The currency basket, which consists of the US dollar, euro, British pound sterling and Japanese yen, is reviewed every five years.
In 2010, the IMF rejected the renminbi on the grounds that it is not freely convertible.
However, a new effort for its inclusion is gaining traction given the renminbi is now the world’s fifth most traded currency.
At the recent National People’s Congress, PBoC deputy governor Yi Gang expressed hope that the renminbi would become a reserve currency in the SDR basket.
Bank of America Merrill Lynch estimates a 2 percent fall in the renminbi to 6.36 against the greenback by the end of the year. It was up 0.06 percent to 6.2129 on Thursday.
“A stable depreciation will happen because of balance of payment flows… but it won’t really influence the IMF’s decision whether to include renminbi in the SDR or not,” he said.
“You do need stability in the currency. Any reserve currency needs to be stable and liquid enough so that central banks can hedge.”
Any depreciation will be gradual. One-off depreciation could lead to big losses in carry trade, he said.
He said renminbi depreciation will be “very mild” over time because China does not want systemic risk from dollar borrowings to undermine its financial market.
A weaker renminbi exchange rate will not deter offshore investors from the Chinese market as long as they can hedge their exposure.
“The bigger factors for big offshore investors like real money investors, pension funds, central banks… is not the long-term direction of the exchange rate. What they want is liquidity. They want to be able to hedge their exposure,” Sinha said.
“The larger the market, or the more liquid it is, the lower their transaction costs tend to be,” he said.
“If they [China] widen the band, allow more liquidity and allow more internationalization, longer-term demand for renminbi assets will be supported.”
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