Renmenbi's SDR Inclusion - More Yuan Denominated Assets?
At the end of November the International Monetary Fund (IMF) approved the inclusion of the Chinese Renminbi (RMB) into the IMF’s Special Drawing Rights (SDR) basket of currencies. This came after years of lobbying by Beijing which hopes to broaden the use of the RMB in international trade and finance, an important step in integrating the Chinese economy into the global financial system.
A currency in the SDR basket has to satisfy 2 criterions; that it is widely used in international transactions and that it can be freely traded in foreign exchange markets. The RMB easily satisfies the first criterion but falters on the second as it imposes capital control measures and limits international convertibility of the RMB. Inclusion in the SDR would put pressure on Beijing to liberalize its financial markets and reassess its RMB management policy to allow full-convertibility of the RMB in international money markets. The RMB’s internationalization would be greatly helped by the ‘One Belt One Road’ (B&R) initiative and through the Asian Infrastructure Investment Bank (AIIB) by creating incentives for investors to make investments in RMB and consider extending low or interest-free loans when providing development aid.
China has taken steps to increase access to its capital markets and reduce restrictions on foreign investments. The ‘Shanghai-Hong Kong Stock Connect’, inaugurated to much aplomb last year, allows foreign investors to purchase Chinese equity securities in Shanghai without government approval and a similar plan is in the works for securities listed on the Shenzhen Stock Exchange. Last month, a newly integrated index that tracks exchange rates between the RMB and the currencies of B&R regions will provide real-time quotes and professional analyst reports. This index would be beneficial for trade liberalization and investment facilitation by increasing the acceptance and usage of RMB in globally, especially in B&R regions. Allowing investors to better forecast currency trends and adopt hedging measures to reduce non-operating risk would incentivise countries with strong trade and funding ties with China to increase RMB holdings.
However, investors and deregulation enthusiasts should not be too hopeful just yet. While significant steps has been taken to allow foreign investors more access to its stock market, liberalization of its debt capital market has been slow. In response to questions regarding the ‘full convertibility’ criteria of SDR inclusion, Pan Gongshen, deputy governor of the People’s Bank of China (PBoC), said that the PBoC’s vision of full convertibility of the RMB does not mean unrestricted capital flows which created disorder in the emerging markets as seen during the Asian Financial Crisis in 1997 and the 2008 Great Recession. Pan added that capital liberalization is a gradual process that should not be rushed and a policy of ‘managed convertibility’ would be promulgated instead.
SDR inclusion should encourage China to stick to overdue financial and capital-account liberalization. While there exists special arrangements between the PBoC and other central banks which gives them ameliorated access to China’s bond markets, the ability for private foreign investors to increase RMB holdings is crippled by China’s capital controls. Another obstacle for increasing RMB holdings is the perceived lack of transparency and market manipulation by Chinese regulators. In recent months, record levels of capital outflows precipitated by a stock market rout and declining exports has shown a structural weaknesses in China’s financial markets. The government’s delayed efforts to prop up the stock market and reverse capital flight using foreign reserves implies that the government itself doesn’t trust domestic market forces and its reluctant response and ambiguity in intervening in the currency and stock markets are making investors wary.
Capital controls liberalization and transparency could be a catalyst for portfolio reallocation and is required to for asset reallocation into Chinese capital markets. As fixed income assets make up a significant holdings of sovereign wealth, pension and mutual funds, increased international investment in China’s bond markets could be a hedge against a slowing economy and declining domestic interest rates. Until capital control and transparency issues are addressed, inclusion of the RMB into SDR basket is unlikely to speed up the pace of diversification into Chinese assets.
In the long-term, the RMB will need to hold its own against the vagaries of market forces to improve capital efficiency and trade. Capital accounts liberalization, economic growth and consistency in market intervention policies are crucial in convincing international investors to store assets denominated in RMB. The PBoC should allow market forces to play out and not be too eager in intervention. A more market-oriented system is crucial for Chinese capital markets to improve internal financial stability to reduce systemic risk.
WRITTEN BY FELIX LIM FOR BESA
PLEASE DIRECT ANY INQUIRY TO AS.BESA@UNIBOCCONI.IT
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