Jukka Pihlman: IMF Decision Could Propel Renminbi Past Sterling and Yen

2015-12-01 IMI

Jukka Pihlman, Managing Director and Head of Central Banks and Sovereign Wealth Funds, Standard Chartered Bank. The Chinese currency’s path to internationalisation has been stellar so far but something may happen this year that could propel the renminbi (RMB) into the currency stratosphere. The International Monetary Fund’s (IMF) Special Drawing Rights (SDR) – the IMF’s ‘virtual currency’ based on a basket of other currencies reviewed every five years – rarely warrant much excitement. But if the RMB gets included in 2015, alongside the dollar, euro, pound and yen, it could boost the Chinese currency’s fortunes overnight. Due to the sheer magnitude of Chinese exports – China is the world’s largest exporter of goods and services and exports is the key determinant of the currencies’ weights in the SDR basket – RMB would go straight past the yen and the pound to make it the third-highest-weighted currency in the SDR. It is hard to overestimate the importance of this move to the global adoption of RMB. Automatically, all central banks would become holders of RMB exposure through their SDR assets and the official recognition of the RMB’s reserve currency status would spur RMB investment by central banks all over the world. The IMF loans to its member countries are denominated in SDR, so countries in IMF programmes would be partially exposed to RMB fluctuations and the interest rates paid on these loans would also become slightly higher than currently as Chinese interest rates are higher than those of the current SDR currencies. Perhaps the biggest direct and immediate impact would be on some international institutions such as the African Development Bank and Bank of International Settlements, whose balance sheets are denominated in SDR. Inclusion of RMB to SDR would lead to a significant hedging demand for the RMB as SDR hedging in the markets needs to be done in the constituent currencies. Last time the IMF reviewed the composition of the SDR, in 2010, it concluded the RMB did not meet the key criteria of being a freely usable currency. But a lot has changed since, making this year’s decision much more finely poised. Most of the indicators used in determining the ‘free usability’ of a currency, such as foreign exchange trading volume and payments in that currency, have experienced significant growth, with RMB now ranked fifth as a global payment currency according to Society for Worldwide Interbank Financial Telecommunications (SWIFT) data. According to Standard Chartered Renminbi Globalisation Index, the RMB is now over 20 times more internationalised than it was at the start of 2011. These are all factors that the IMF will have to take into account. Looking at the official reserves of central banks – another important criterion for admission into the SDR club – the IMF may also want to note that, while the amounts remain relatively low, at least 60 of these central banks have already begun to invest in RMB as part of their reserves. Most central banks in Asia and South America have been investing in RMB for years, but news about a number of European central banks including the Bank of England, Banque de France and Swiss National Bank investing in RMB and recent reports that even the European Central Bank is considering adding the RMB to its reserves are highly significant developments and shows how rapidly attitudes to the RMB are changing. However, the IMF faces a classic ‘chicken and egg’ situation: until it confers official reserve currency status on to the RMB, there will be no official data showing the proportion of global central bank reserves invested in the currency. The only way of gauging the overall amount of RMB investment under current conditions would be to gain information directly from the People’s Bank of China and through informal surveys of market participants. Nevertheless, the fast-paced adoption of the RMB by central banks and the inclusion of RMB in their reserves – underpinned by the Chinese authorities’ continued and conscious efforts in making the RMB more accessible – could help swing the IMF decision in the RMB’s favour. The final decision is in part discretionary and politics will invariably play a part. But supporters of the RMB’s inclusion may draw comfort from the fact that changes to the SDR composition are relatively ‘easy’ to vote through. Most big IMF decisions require an 85 per cent majority, effectively giving the US, with its almost 17 per cent share of the vote, the power of veto. However, according to Article XV of the IMF’s Articles of Agreements, the IMF Executive Board can make the SDR decision with only 70 per cent of the vote, provided there is no change to the methodology. More importantly, the Europeans have indicated by their actions that they are unlikely to stand in the RMB’s way, as long as the technical argument stacks up. France, Germany, Italy and the U.K. have joined the China led Asian Infrastructure Investment Bank (AIIB) as founding members and many other European countries are likely to follow. Most significant and explicit support thus far came from Germany as they officially announced that “the German side supports China's goal to add the RMB to the SDR currency basket based on existing criteria” at the conclusion of the First China-Germany High-Level Financial Dialogue on 17 March 2015. For many central banks, especially smaller ones and those on IMF programmes, the SDR decision will have huge significance. Many of these countries will already be experiencing increased trade with China, making it increasingly sensible for them to hold RMB reserves. But the fact that RMB investment cannot currently be reported as part of a central bank’s official reserves means many are holding back from this logical step. At the very least, even if the IMF chooses not to include RMB in its drawing rights, it will need to address this urgent reporting issue. Otherwise, by the time the next SDR review comes around in 2020, there will be no official reserve statistics on which to base the decision – despite the fact that by then the RMB is likely to have become the world’s fourth most used trading currency, accounting for close to 35 per cent of China’s trade. The RMB is very far from challenging the Dollar’s dominance as an official reserve currency. More than three fifths of central bank reserves are still held in the US currency. But with China now accounting for over 11 per cent of all world trade, and the RMB fast growing in stature, the big decision on whether to officially admit the Chinese currency to the club is not one the IMF will be able to postpone forever. The writer is managing director and Head of Central Banks and Sovereign Wealth Funds at Standard Chartered Bank. He previously worked for the IMF and the central banks of New Zealand and Finland.

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Jukka Pihlman: IMF Decision Could Propel Renminbi Past Sterling and Yen

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