Is the world about to get a new re­serve cur­rency?

Financial Mirror (Cyprus) - - FRONT PAGE -

The In­ter­na­tional Mone­tary Fund (IMF) cre­ated what is known as Spe­cial Draw­ing Rights (SDRs) back in 1969. This serves as an of­fi­cial global re­serve as­set used for the pur­poses of sup­ple­ment­ing the re­serves of a coun­try’s money sup­plies.

The Spe­cial Draw­ing Rights re­serve as­set is based upon the val­ues of 4 ma­jor cur­ren­cies: GBP, EUR, USD and JPY. This ex­clu­sive group of cur­ren­cies has hereto­fore en­joyed sta­tus as the world’s of­fi­cial re­serve cur­ren­cies. Now, an­other cur­rency is likely to join the ranks and it is none other than the Chi­nese yuan – CNY. IMF rep­re­sen­ta­tives have in­ti­mated that China will likely be­come the fifth in a bas­ket of cur­ren­cies with SDRs.

SDRs af­ford each of the mem­ber coun­tries the right to draw any of the re­quired cur­ren­cies in the bas­ket in or­der to meet the needs of their bal­ance of pay­ments. Each of the four cur­ren­cies in the SDR is weighted ac­cord­ing to spe­cific re­quire­ments. For ex­am­ple, in Au­gust, the United States re­ported that it had ap­prox­i­mately $50 bln in SDR hold­ings. In Septem­ber 2015, an equiv­a­lent value of some $280 bln in SDRs was dis­sem­i­nated to IMF mem­bers. The Chi­nese gov­ern­ment is par­tic­u­larly fond of the idea that it is now be­ing in­cluded as part of the elite group of cur­ren­cies with SDR sta­tus.

This is im­por­tant given the mas­sive global un­cer­tainty that has rocked the mar­kets since 2009. At crit­i­cal junc­tures like that, the global mone­tary sys­tem is heav­ily re­liant on cur­ren­cies like the USD. Now that China holds the of­fi­cial sta­tus as the #2 econ­omy in the world, it is be­fit­ting for the Asian gi­ant to be in­cluded in this elite club. For China there is a de­gree of pres­tige in­volved in this lat­est de­ci­sion. That China has been in­vited, and en­dorsed by sev­eral coun­tries to join the IMF’s SDR is a no­table achieve­ment. This is be­ing hailed by some as a just re­ward for mov­ing to­wards a more mar­ket-based eco­nomic sys­tem. De­spite the fact that the CNY was re­jected for in­clu­sion in the SDR in 2010, the wide­spread us­age of this cur­rency has surged in the five years since. As at Au­gust, a to­tal of 2.79% of all global pay­ments pro­cess­ing was con­ducted with this cur­rency. That places the CNY above the JPY.

The Chi­nese gov­ern­ment has re­jected the use of SWIFT for money trans­fer pur­poses. This cross-bor­der pay­ment sys­tem is re­spon­si­ble for han­dling most of the world’s pay­ments trans­fers, but China uses its own sys­tem known as CIPS (China In­ter­na­tional Pay­ment Sys­tem). The Chi­nese cross-bor­der CNY pay­ments trans­fer sys­tem is mod­elled af­ter the US Clear­ing House Pay­ment sys­tem, and the rea­son why China es­tab­lished its own is be­cause it doesn’t want to use Western-based ones. In the event that sanc­tions are im­posed on China, it wants to be in con­trol of the money pay­ments sys­tem – not to leave it in the hands of Western coun­tries.

The IMF makes use of sev­eral mea­sures to de­ter­mine how freely us­able a par­tic­u­lar cur­rency is. This is how it de­ter­mines a cur­rency’s el­i­gi­bil­ity for in­clu­sion in the SDR. There have been re­ports by mem­bers of IMF com­mit­tee stat­ing that the Chi­nese yuan is lag­ging many other cur­ren­cies in terms of cur­rency trad­ing, forex re­serves and debt hold­ings. How­ever, the ex­ec­u­tive di­rec­tors of the IMF will be the ones mak­ing the fi­nal de­ci­sion as to whether to in­clude the CNY as part of the IMF’s SDRs. Just re­cently, the Chi­nese pre­mier trav­elled to Lon­don to agree to a multi­bil­lion pound deal be­tween China and the UK. This will cover mul­ti­ple sec­tors (150 com­pa­nies) such as air­craft manufacturing, cars and oth­ers. China is in­creas­ingly mov­ing to­wards en­hanced re­la­tions with the UK, and this bodes well for the cur­rency.

The world’s most suc­cess­ful economies in­clud­ing the UK, the US, Ger­many, France and oth­ers see no rea­son not to en­dorse the Chi­nese ren­minbi pro­vided it meets all of the re­quire­ments as set out by the IMF. By in­clud­ing China as part of the fund, a ma­jor com­po­nent of the global econ­omy now has rep­re­sen­ta­tion in an elite club. What is likely to hap­pen as a re­sult of this pend­ing de­ci­sion is a mi­gra­tion of $1 trln in global financial re­serves to China. This has been laid out by the man­age­ment at AXA In­vest­ment and Stan­dard Char­tered Plc. As soon as the CNY joins ranks with the SDR, man­agers of cen­tral banks the world over will be look­ing to rack up as many CNY-de­nom­i­nated as­set hold­ings as pos­si­ble. From its per­spec­tive, China will do well to wel­come as many dif­fer­ent is­suers as pos­si­ble in the Chi­nese on­shore mar­ket.

When the IMF holds its of­fi­cial meet­ing in Novem­ber, the is­sue of China’s ad­mis­sion will come to the fore. There are, how­ever, sev­eral cri­te­ria that need to be met be­fore China gains ac­cep­tance to the SDR. Th­ese in­clude the CNY be­ing a freely us­able cur­rency – no prob­lems there, and China must be a ma­jor trad­ing coun­try – no prob­lems there either. The Chi­nese are not idly sit­ting around wait­ing for the IMF de­ci­sion with­out tak­ing ac­tion into their own hands. China has now opened up its bond mar­kets to for­eign­ers with what is known as the Panda bond mar­ket. By 2020, this could be worth as much as $50 bln ac­cord­ing to an­a­lysts.

The fact that the Chi­nese gov­ern­ment is seek­ing greater trans­parency in its busi­ness deal­ings is cer­tainly help­ing it to gain ap­proval with the IMF. A freely-float­ing ex­change rate is also warmly wel­comed by the US, UK, Ger­many and Ja­pan. That’s pre­cisely what the Chi­nese are al­low­ing vis-a-vis de­mand/sup­ply of their cur­rency. Other eco­nomic data re­leased by China such as gold re­serves, forex hold­ings, PMI, GDP and the like are fur­ther ev­i­dence of China’s move to­wards a more mar­ket-based econ­omy with greater trans­parency of eco­nomic data.

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