By Jukka Pihlman
Political momentum is building behind an International Monetary Fund (IMF) decision that could boost the global fortunes of the Chinese currency overnight.
Later this year, the IMF will decide whether to include the renminbi (RMB) in its Special Drawing Rights (SDR) – a ‘virtual currency’ made up of a basket of other currencies.
If this happens, RMB use around the world is set to soar. Automatically, all central banks would become holders of RMB exposure through their SDR assets, and official reserve currency status would spur those central banks that have not already done so to invest part of their reserves in RMB.
There would be significant RMB hedging activity by some international institutions such as the African Development Bank and Bank of International Settlements and Islamic Development Bank, whose balance sheets of over USD350 billion combined are denominated in SDR (or SDR equivalent units).
"By reducing reliance on the dollar, it would have the added benefit of making the international monetary system more stable"
With the IMF’s official stamp of approval, RMB use would become more legitimate, boosting demand among investors and private companies. One example could be the Basel III Liquidity Coverage Ratio regulation, which requires the High Quality Liquid Assets held by banks to be in convertible currencies. Whether or not the RMB qualifies is up to regulators, but the IMF’s decision could play a part.
The final decision on the currency’s inclusion in the SDR is to a large extent political, and, judging by recent noises, it now seems significantly more likely that it will go in RMB’s favour.
At the China Development Forum in Beijing last month, Governor Zhou Xiaochuan of the People’s Bank of China (PBOC) publicly pushed for the RMB’s inclusion in the SDR, suggesting that China is now reasonably comfortable about the chances of this symbolic move happening.
For the first time, the PBOC explicitly connected the SDR goal with further opening of its capital account, as Governor Zhou pledged to ease controls, confirming plans to make China’s capital account convertible by the end of this year.
"Central banks in Africa, South America and Asia, including the Central Bank of Sri Lanka, have been investing in RMB for a while"
The IMF itself seems increasingly supportive, after rejecting the RMB’s inclusion during the last SDR review in 2010 on the grounds that the currency did not meet the criteria of being ‘freely usable’.
In her response to Governor Zhou, IMF Managing Director Christine Lagarde said that RMB “clearly belongs” in the SDR basket and that the IMF welcomes and shares China’s objective, and “will work closely with the Chinese authorities in this regard”.
In Europe – whose member governments have the largest combined share of the vote at the IMF – the atmosphere is turning increasingly favourable, with Germany declaring officially last month that it supports the RMB’s inclusion in the SDR.
Along with France, Italy, Switzerland and the UK, Germany has also recently joined the China-led Asian Infrastructure Investment Bank as founding members, in a show of political support for the Chinese authorities.
Even before the IMF has made its decision, more than 60 central banks have already invested in RMB despite the fact that, according to the IMF, it cannot yet be reported as part of their official reserves.
By our estimates, more than USD100 billion of central bank reserves are now invested in the RMB, considerably more than in the Swiss Franc, roughly on par with the known amounts of Australian and Canadian dollar investments, and fast catching up with the yen and the pound.
Central banks in Africa, South America and Asia, including the Central Bank of Sri Lanka, have been investing in RMB for a while, but the recent news that European central banks, including the Bank of England, Banque de France, National Bank of Hungary and Swiss National Bank, are following suit shows how rapidly attitudes to the RMB are changing.
Even the European Central Bank is now considering adding the RMB to its reserves, according to media reports. This – along with the rapid growth in the use of RMB for trade and financial transactions – lends significant weight to the argument in favour of the currency’s inclusion in the SDR later this year.
Since 2010, the RMB has seen significant growth in most of the indicators used in determining the ‘free usability’ of a currency, such as international banking liabilities, foreign exchange trade and payments.
According to Swift data, the RMB now hovers between being the fifth and the seventh most used currency for payments around the world. We’ve been tracking the RMB’s meteoric rise on our Standard Chartered Renminbi Globalisation Index since the start of 2011, and the RMB is 21 times more internationalised now than it was then.
Lukewarm US response
How the US will play its cards will be interesting – so far, the official statements from Washington have been lukewarm at best.
However, it is worth noting that, whereas most big IMF decisions require an 85 per cent majority, effectively giving the US a veto, the SDR decision can be made with only 70 per cent of the vote, if there’s no significant change to the methodology.
If not now, the next SDR review is not till 2020. The IMF can theoretically conduct a review outside of those times, but this would be ill advised and at odds with the IMF’s stated aim to promote broader use of the SDR. Adding additional uncertainty about the timing of an SDR review would seriously hamper the SDR’s prospects of becoming anything more than it is today.
More stable int’l monetary system
By contrast, including the RMB this year would instantly make the SDR more reflective of the realities of the new world economy in which China is the largest exporter and has the second-largest GDP. By reducing reliance on the dollar, it would have the added benefit of making the international monetary system more stable.
Christine Lagarde said recently that the IMF’s move is “not a question of if, it’s a question of when”. Given the rapid growth of RMB usage and investment around the world, it seems increasingly likely that the ‘when’ is now.
(The writer is managing director and Head of Central Banks and Sovereign Wealth Funds at Standard Chartered Bank. He previously worked for the IMF and the central banks of New Zealand and Finland.)