The Renminbi Has Joined An Elite Club – Well, Sort Of
2016 is the year of the Renminbi (RMB). First, on January 26, the IMF Board Amendment Reform went into force and lifted China’s IMF voting share from 3.82 percent to 6.09 percent. Second, since October 1, the RMB finds itself in company of an elite group of currencies, when it becomes the fifth member of the International Money Fund’s (IMF) basket of leading international currencies determining the the value of the Special Drawing Rights (SDR). So far, only the US Dollar, the Euro, the Japanese Yen and the Pound Sterling formed the SDR basket.
We talked to Prof. Rolf J. Langhammer about this decision, its impact on a global scale and what it means for Asian financial markets. He is a Professor of Economics, former Vice President of the Kiel Institute for World Economy and expert on China’s economy. An opinion piece by the author on the same topic was first published on the Mercator Institute for China Studies’ blog “European Voices on China”.
GESblog: Last time we talked about the RMB on this blog, it was about China’s reserve situation. Back then, in June, you mentioned that the RMB was going to become part of the SDR in October. That has just happened. What does this mean?
Prof. Langhammer: The biggest numerical change we see so far will be a more accurate reflection of the actual weights in the global economy. Just like the voting rights reform, when China’s IMF voting share was lifted from 3.82 percent to 6.09 percent. In the SDR, the RMB will have a share of 10.9 percent, taking most from the Euro, whose share declines from 37.4 to 30.9 percent.
GESblog: What is the idea behind the SDR?
Prof. Langhammer: The SDR is a potential claim on the freely usable currencies of IMF members”. It was established by the IMF in 1969 to supplement its member countries’ official reserves and to help the IMF provide liquidity to member states in times of balance of payments crises. Back then, the Bretton Woods System worked basically with only two reserves, gold and US dollars. That system didn’t work out as we all know, but the SDR remained, yet only with a smaller significance as originally intended.
GESblog: The RMB’s share is higher than that of the Japanese Yen and the Pound Sterling. Does that make it a real global currency, the No. 3 behind the US Dollar and the Euro?
Prof. Langhammer: Things are a little bit more complicated, I’m afraid. The Chinese currency still seems a long way from assuming a leading role as a reserve currency, let alone from challenging the Euro or the US Dollar. It is also unlikely to promote the role of the SDR, which remains a unit of account and a mode of liquidity provision for the IMF. As long as financial markets in the US, Europe and Japan remain stable, open and liquid, central banks around the world will prefer to hold their reserves in one of the established leading currencies or in gold rather than in SDR nor RMB. For example, the SDR share of Germany’s exchange reserves is less than ten percent.
GESblog: So what keeps the RMB from becoming a truly global currency?
Prof. Langhammer: The RMB has not yet matured into a truly global currency – at least not in the world’s private financial markets. The IMF Board decision was a recognition of China’s currency as a gradually rising asset currency and as an important invoice currency in trade. Plus, there are more qualifications to match: To be a global currency, the RMB needs to be used as a transaction currency, an asset currency and a reserve currency. Investors have to view it as a store of value being the third function of money. . So far, however, the RMB, , can neither be used as a store of value for investors in government bonds, nor is it freely usable for portfolio or direct investors in China.
GESblog: Where does this limitation as a store of value and for direct investments come from?
Prof. Langhammer: Capital imports into China or exports from China are still subject to restrictions. Chinese domestic financial markets are neither efficient nor competitive. Moreover, the exchange rate of the RMB is not determined by the markets but remains pegged to a multiple currency basket whose composition is determined by the People’s Bank of China (PBOC). This method allows for more fluctuation than the single US dollar peg in the past, but the US dollar still has the largest weight in this basket. This makes the RMB the only SDR basket currency, which does not freely float against the other currencies but remains subject to market intervestions of the PBOC Therefore, it does not yet offer good options to hedge against exchange rate volatilities of the other four currencies.
GESblog: So is there any significant effect we can expect from the RMB becoming a part of the SDR?
Prof. Langhammer: Oh yes, and it will be a regional and market-specific one. It will mostly affect those Asian countries, which have started to invoice their trade with China in RMB and/or have concluded swap arrangements with China as support in balance of payments crises. Under these arrangements, China offers stand-by loans in RMB (for instance, through the Chiang Mai Initiative with ASEAN economies). In the past, crisis-ridden countries could use these loans to service international debts in currencies other than the RMB only under certain restrictions (such as conversion of RMB into Western currencies by the PBOC or direct acceptance of RMB by Western creditors). Now, the IMF Board decision strongly facilitates the use of RMB straightforwardly as a currency to cover international debt worldwide.
GESblog: Which role do international public institutions play in making the RMB more acceptable?
Prof. Langhammer: They act as icebreakers for promoting non-traditional currencies in asset markets. The World Bank just issued the first bonds in the Chinese domestic market in SDR and payable in RMB.
GESblog: A final question, what is your point of view on how the RMB will develop as a global currency?
Prof. Langhammer: The examples I just mentioned are about very special markets protected by triple A ratings of their state owners. The RMB will take much longer to penetrate private financial markets. Before they will be able to enjoy the benefits of issuing an asset currency, such being able to serve debts in RMB or paying a lower risk premium on interest rates, China’s will first have to create a stable, transparent, open and non-discriminatory environment for trade and capital flows. The IMF has taken a vote of confidence with regard to the RMB. It will now be up to China’s authorities to do their homework and prove that this vote was not misplaced.