Inside investment: Rights and responsibilities of the renminbi
China’s bid to join the currencies in the IMF’s SDR basket is more than a footnote of interest only to economists. Policymakers should take note.
China's premier Li Keqiang shakes hands with IMF chief Christine Lagarde during the China Development Forum inside the Great Hall of the People in Beijing earlier this year
Meissen pottery from the early 18th century is highly prized and very rare. It was the first manufacturer of porcelain in Europe and the technology was imported, via the Dutch East India Company, from China.
These days, technology transfer flows the other way. Since 2014 China has been on a US ‘priority watch list’ for intellectual property violations. The US has been less willing to label China as a currency manipulator, in spite of it accumulating $3.4 trillion in reserves.
The last time it did so was in 1994 when Chinese reserves were $52.9 billion. This is important in the context of the current bid by China for the renminbi to join the basket of currencies represented in the IMF’s Special Drawing Rights.
Currently the SDR is composed of the US dollar, euro, sterling and yen. The weights are decided by the prominence of currencies in international trade.
Those SDR weights are more or less reflected in the currencies held by global central banks and monitored by the IMF’s Cofer (currency composition of official foreign exchange reserves) database.
Reserve currency status is not just a nice thing to have. It is a powerful economic tool. Ironically, the one thing most reserve currencies lack is large reserves. They do not need them. They can print money and exchange them for SDRs.
Why now kowtow?
The case for the RMB is meaningful (and supported by bankers and governments keen to have a slice of this trade). The renminbi, according to figures from global clearing system Swift, has displaced the US dollar and Japanese yen as the main payment currency between China and the rest of the Asia-Pacific region. It is now used for almost one third of all transactions.
This is all part of a concerted campaign to internationalise the RMB that seems irresistible. There has a been a 68% increase in foreign investors’ holdings of Chinese bonds during 2014, but they still hold less than 2% of the Chinese domestic bond market. Bank of China’s issue of a record $3 billion, four currency-denominated bond deal opens the market further.
Policymakers should recognise that the
The deal was divided into 10 tranches in dollars, euros, Singapore dollars and offshore renminbi. It was explicitly marketed as supporting China’s plans to extend its global influence under the ‘One belt, one road’ (OBOR) policy. It includes ambitions such as building infrastructure and trade routes between central Asia, the Middle East and Europe over land and related projects such as the China-Pakistan Economic Corridor, the Bangladesh-China-India-Myanmar economic corridor and a maritime Silk Road.
The official launch of the Asian Infrastructure Investment Bank in the same month is no coincidence. This is the first international development bank launched without US backing in the post-Bretton Woods era. The decision of the UK and other western allies to sign up to it is shamefully self-interested.
Resistible rise of the renminbi
The IMF cannot and should not ignore the rise of the renminbi and its role in global trade. Its inclusion in the SDR basket seems inevitable. But with rights, special or otherwise, come responsibilities.
Policymakers should recognise that the artificial weakness of the RMB has been a deliberate act of a mercantilist economic policy. It has played a role in hollowing out western competitiveness.
There have been noises off in China about a devaluation to counter recent dollar strength. That would be unacceptable and is not the central case. China is more likely to continue to loosen financial conditions to stave off the deflationary impact of a weaker euro and yen.
The IMF is in a strong position. China’s vaunted $3.4 trillion of reserves are not a source of strength as they are often depicted. Even the Chinese central bank governor accepts that the reserves “exceed our reasonable requirements”.
If China has reserve currency status, it would need less reserves. But the old adage applies: If you owe your bank £1,000 you have a problem, if you owe them £1 million the problem is theirs. And $3.4 trillion is a big problem.
The Chinese central bank, to maintain its competitiveness, buys the US dollars that its exporters hoover up by selling RMB. This is then sterilized.
China is in a dollar trap. It could sell its dollar holdings, though the price action in US treasuries if the State Administration of Foreign Exchange was a confirmed seller would be interesting.
But even if China could sell, bringing those dollars back onshore, the result would be massive domestic inflation.
The IMF and other financial institutions should respect and recognise the increasing role of China in world trade. But it should not do so at any price.
Opening the SDR to a broader range of currencies in addition to the RMB would make it even more relevant.