The ir­re­sistible rise of the ren­minbi

Financial Mirror (Cyprus) - - FRONT PAGE - By Lee Jong-Wha

By the end of this year, the In­ter­na­tional Mon­e­tary Fund will de­cide whether the Chi­nese ren­minbi will join the euro, the Ja­panese yen, the Bri­tish pound, and the US dollar in the bas­ket of cur­ren­cies that de­ter­mines the value of its in­ter­na­tional re­serve as­set, the Spe­cial Drawing Right (SDR). China is push­ing hard for the ren­minbi’s in­clu­sion. Should it be ad­mit­ted?

The IMF cre­ated the SDR in 1969 to sup­ple­ment ex­ist­ing re­serve cur­ren­cies, thereby pro­vid­ing the global fi­nan­cial sys­tem with ad­di­tional liq­uid­ity. As it stands, the SDR’s role re­mains largely limited to IMF op­er­a­tions; its share in global fi­nan­cial mar­kets and cen­tral banks’ in­ter­na­tional re­serves is neg­li­gi­ble. Nonethe­less, adding the ren­minbi to the SDR bas­ket would be sym­bol­i­cally im­por­tant, im­ply­ing recog­ni­tion of China’s grow­ing global stature. The ren­minbi is al­ready a ma­jor cur­rency for world trade and in­vest­ment, and ac­counts for a grow­ing share of in­ter­na­tional fi­nan­cial trans­ac­tions and re­serve hold­ings.

To qual­ify for in­clu­sion, the Chi­nese gov­ern­ment has eased its cap­i­tal con­trols and lib­er­alised its fi­nan­cial mar­kets con­sid­er­ably.

In­clu­sion in the SDR bas­ket would re­quire con­tin­u­ing this process, which, to­gether with the ren­minbi’s emer­gence as a glob­ally in­vestable cur­rency, would ben­e­fit the en­tire world econ­omy.

The IMF’s largest share­hold­ers – the United States, Europe, and Ja­pan – should thus wel­come the ren­minbi’s ad­di­tion to the SDR bas­ket. Yet opin­ions on the mat­ter have been di­vided, with the US, in par­tic­u­lar, re­luc­tant to wel­come China into the fold.

This is all the more prob­lem­atic given that the 2008 fi­nan­cial cri­sis laid bare the in­ter­na­tional re­serve sys­tem’s in­ad­e­quacy when it comes to en­sur­ing suf­fi­cient liq­uid­ity for emerg­ing economies. Although emerg­ing economies have since ac­cu­mu­lated larger for­eign-ex­change re­serves and strength­ened fi­nan­cial su­per­vi­sion and reg­u­la­tion, they re­main vul­ner­a­ble to ex­ter­nal shocks, es­pe­cially from the US, the eu­ro­zone, and Ja­pan. All three have lately em­ployed ex­pan­sion­ary mon­e­tary poli­cies; and, as the US Fed­eral Re­serve nor­malises its pol­icy, emerg­ing economies will be hit again by a sud­den with­drawal of global liq­uid­ity.This con­tin­ued vul­ner­a­bil­ity re­flects a col­lec­tive fail­ure to re­form the global mon­e­tary sys­tem – an i mper­a­tive that Peo­ple’s Bank of China (PBOC) Gover­nor Zhou Xiaochuan high­lighted in early 2009. Per Zhou’s pro­posal, China has cham­pi­oned a tran­si­tion to a multi-cur­rency re­serve sys­tem, in which the SDR and an in­ter­na­tion­al­ized ren­minbi would be used more widely, in­clud­ing in coun­tries’ cur­rency re­serves. But its at­tempt in 2010 to add its cur­rency to the SDR bas­ket failed, be­cause the ren­minbi was not “freely us­able.”

Since then, China has im­ple­mented a se­ries of re­forms to in­crease the ren­minbi’s us­age in for­eign trade and di­rect in­vest­ment, as well as in cross-bor­der fi­nan­cial in­vest­ment. Four­teen ren­minbi-clear­ing banks have been es­tab­lished world­wide. Last year, the Shang­hai-Hong Kong Stock Connect was launched to stim­u­late cross­bor­der in­vest­ment and cap­i­tal-mar­ket devel­op­ment. And China has signed bi­lat­eral cur­rency-swap agree­ments with 28 cen­tral banks, in­clud­ing the Cen­tral Bank of Brazil, the Bank of Canada, the Euro­pean Cen­tral Bank, and the Bank of Eng­land.

This year, Chi­nese pol­i­cy­mak­ers have sig­naled fur­ther fi­nan­cial lib­er­al­i­sa­tion by re­mov­ing the do­mes­tic cap on banks’ de­posit rates, thereby giv­ing over­seas in­sti­tu­tional in­vestors eas­ier ac­cess to cap­i­tal mar­kets. The PBOC is also likely to widen the cur­rency’s trad­ing band and move to­ward a more flex­i­ble ex­change-rate regime.

As a re­sult of th­ese ef­forts, the ren­minbi has emerged as the sec­ond most used cur­rency in trade fi­nance, over­tak­ing the euro, and the fifth most used for in­ter­na­tional pay­ments. More­over, it is in­creas­ingly pre­ferred in cur­rency-mar­ket trans­ac­tions and of­fi­cial for­eign-ex­change re­serves.

Of course, China stands to gain much from the ren­minbi’s emer­gence as an al­ter­na­tive in­ter­na­tional re­serve cur­rency, shar­ing in the “ex­or­bi­tant priv­i­lege” that the US cur­rently en­joys by virtue of the dollar’s global sta­tus. Be­yond the con­ve­nience of con­duct­ing in­ter­na­tional trans­ac­tions in lo­cal cur­rency, China would be able to take ad­van­tage of seignior­age – safe in the knowl­edge that it would not face a bal­anceof-pay­ments cri­sis.

But, in or­der to reach that point, China must con­front sig­nif­i­cant risks. Cap­i­ta­lac­count lib­er­al­iza­tion and ren­minbi in­ter­na­tion­al­i­sa­tion in­vite po­ten­tially volatile cross-bor­der cap­i­tal flows, which could, for ex­am­ple, trig­ger rapid cur­rency ap­pre­ci­a­tion. Given this, China can be ex­pected to con­tinue to man­age cap­i­tal-ac­count trans­ac­tions to some ex­tent, us­ing macro­pru­den­tial mea­sures and, when ap­pro­pri­ate, di­rect cap­i­tal con­trols.

Even if China man­ages to mit­i­gate such risks, un­seat­ing the US dollar as the dom­i­nant global cur­rency will be no easy feat. In­er­tia favours cur­ren­cies that are al­ready in use in­ter­na­tion­ally, and China lacks deep and liq­uid fi­nan­cial mar­kets, an im­por­tant pre­con­di­tion that any in­ter­na­tional re­serve cur­rency must meet. Fur­ther­more, China’s bank­ing sys­tem, which re­mains sub­ject to ex­ten­sive gov­ern­ment con­trol, lags far be­hind those of the US and Europe in terms of ef­fi­ciency and trans­parency. If, how­ever, China suc­ceeds in de­vel­op­ing a more con­vert­ible cap­i­tal ac­count and bol­ster­ing its fi­nan­cial sys­tem’s ef­fi­ciency, the ren­minbi is likely to emerge as a new in­ter­na­tional re­serve cur­rency, com­ple­ment­ing the US dollar and the euro. This would ben­e­fit com­pa­nies and cen­tral banks alike, by en­abling them to di­ver­sify their for­eign-cur­rency hold­ings fur­ther.

His­tory sug­gests that a shift in global cur­rency dom­i­nance is likely to oc­cur grad­u­ally. For now, China is fo­cused on win­ning the ren­minbi’s in­clu­sion, even with a small share, in the SDR cur­rency bas­ket. The IMF’s ma­jor share­hold­ers should se­ri­ously con­sider it. The ren­minbi’s con­tin­ued in­ter­na­tion­al­i­sa­tion, not to men­tion fur­ther progress on crit­i­cal fi­nan­cial re­forms, would con­trib­ute to the cre­ation of a more sta­ble and ef­fi­cient global re­serve sys­tem.

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