22 October 2019
Adding the reminbi to the SDR basket won’t have any material impact on international trade and financial transactions. Photo: Xinhua
Adding the reminbi to the SDR basket won’t have any material impact on international trade and financial transactions. Photo: Xinhua

SDR or not, renminbi has long road ahead to true global status

The International Monetary Fund (IMF) issued a new staff report on Nov. 13 supporting the inclusion of the renminbi in the Special Drawing Rights (SDR).

Assuming the IMF executive board approves it at its meeting on Nov. 30, the question is what will come next?

What are the implications of the renminbi being an SDR currency?

Will the global economy and financial markets benefit from an era of greater stability going forward, with the renminbi providing an alternative source of global liquidity?

In recent years, investors and governments drawn to the liquidity and security of the US dollar have relied extensively on the dollar, resulting in dislocations as well as benefits) including historically low borrowing costs in the 2000s that built asset bubbles.

Is there hope we now begin a shift away from the US dollar dominance?

The renminbi’s SDR status, if approved, will be strategically important for China. It will confirm the international community’s official recognition of China’s economic ascendancy, its structural reform efforts and the emergence of renminbi as a reserve currency.

This should act as an external force, as well as a confidence booster, for China to push for further reform, thus improving the structural underpinning for Chinese asset values.

New reform efforts such as expansion of the offshore renminbi market and further opening up of the onshore capital market by expanding the investment quotas and stock connect schemes is likely to proceed faster than other structural reform that will take more time to implement.

Foreign investors, including those from Hong Kong, should have easier access to China’s onshore markets.

More renminbi assets should be made available in the offshore market, with Hong Kong remaining the key CNH center operating alongside a network of other offshore centres.

Being an SDR currency might also create a virtuous cycle where anticipation of deeper renminbi internationalization would prompt more central banks to hold the yuan, which would then actually deepen its internationalization and prompt more central banks to hold more of it.

Global equity and bond indices may also include renminbi assets in their components, so international asset managers will have to include renminbi assets in their portfolios.

However, the immediate impact on global portfolio decisions of the renminbi’s SDR status would not be as significant and as direct as an inclusion of Chinese A hares in the MSCI indices.

MSCI inclusion of Chinese stocks may not be immediate but the international index provider has recently made an initial move by including Chinese stocks that are listed in the US stock market, such as Alibaba and Baidu, in its global emerging market indices

The short-term impact on the global economy and financial markets of the renminbi’s inclusion in the SDR is likely to be limited as the SDR accounts for only about 5 percent of global official reserve asset holdings.

Total SDR is equivalent to about US$300 billion, with the US dollar, euro, pound sterling and Japanese yen accounting for 42 percent, 37 percent 11 percent and 10 percent, respectively, in the SDR basket.

Even if the renminbi were to be included in the SDR with a 14 percent weighting as the IMF staff estimated earlier, central banks’ demand for renminbi via the SDR would amount to just US$42 billion which is negligible in global terms.

After all, the SDR is not a currency, so adding the renminbi to the SDR basket will not have any material impact on international trade and financial transactions.

Regarding the renminbi providing an alternative source of liquidity to global markets (for trade and investment purposes), this is still unlikely in the short-term.

First, its weight in the SDR will be small, so the corresponding liquidity effect on the global system will be small.

Second, the amount of renminbi circulating overseas is limited and China does not have full capital account convertibility.

The amount of renminbi cash circulating overseas is less than 1 percent of China’s broad money supply compared to more than 50 percent of the US dollar circulating overseas

The lack of capital account convertibility means that renminbi cannot flow out of China should offshore renminbi liquidity demand rise, especially sharply in a short period of time.

But the US dollar is free to move among the global markets due to the country’s open capital account.

Last but not least, China’s capital market is still immature, with illiquidity and limited supply of renminbi assets in the offshore market.

This greatly restricts the availability and functionality of the renminbi as a means of global liquidity.

In a nutshell, there is no credible successor to the US dollar as a super global reserve currency in the medium-term.

No other economies or financial markets are large and deep enough to replace the US as a safe haven during crisis periods.

The euro, or even the renminbi, may become an alternative down the road but that is a long way away.

Nevertheless, the renminbi’s inclusion in the SDR is the first step in the international arena that may make this long-term alternative a reality.

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Senior economist of BNP Paribas Investment Partners (Asia) Ltd. and author of “China’s Impossible Trinity – The Structural Challenges to the Chinese Dream”