Yaseen Anwar:Internationalization of the RMB

Distinguished guests, ladies and gentlemen.

It is indeed an honor for me to be here and I am proud to be associated with the premier institution in the world. My brief talk today will reflect a viewpoint as a former Governor of the Central Bank of Pakistan.

The key message I wish to leave you with today is that there are compelling reasons why the RMB should and is likely to be included this year in the IMF Special Drawing Rights (SDR) basket of reference currencies that currently includes Euro, Yen, Sterling, and the U.S. Dollar, but also to ensure a stable International Monetary System going forward with RMB as an alternative Reserve Currency.

It is not in our agenda today to ascertain the causes of the recent Global Financial Crisis, but we must remember the underlying lesson, that our actions and lack thereof can both entail equal consequences, and in this case, the price of lack of collective action led to a near crippling of the Global Economy and the Financial System.  The majority amongst us agrees that the Global Financial Crisis and the ensuing Euro Debt Crisis have exposed infrastructure weaknesses in the incumbent International Monetary System and that the time has come to effect requisite reforms.  After all, Public Trust is at stake.

The International Monetary System refers to the set of rules, policies and institutions that govern international payments for settling trades and capital flows between businesses and nations.  It provides the necessary liquidity to regulate and facilitate the international trade of goods, services as well as official capital account transactions.  A key component of any International Monetary System is the Reserve Management System which ensures that adequate funds are available to continue essential payments in a capital flow crisis.  The Reserve Management System relies upon the selection of reserve currency to act as a unit of account, store of value and medium of exchange.  The Reserve Currency decision is therefore of significant importance for the functioning of the International Monetary System and the choice of reserve currency is a reflection of the collective preference of the international community and that it is an important decision to make, one that is hugely consequential for Global Financial Stability.

Our existing International Monetary System is based on a multiple currency Reserve Management System with the predominance of one single national currency – the U.S. Dollar.  As per IMF data, the dollar comprises 63% of all foreign official reserves while the Euro with 24%.  It is noteworthy that 25 years ago, 65% of reserves were held by developed countries and 35% by emerging markets.  Now the position is reversed with 67% of world reserves held by emerging markets, reflecting the economic role of Asia in general and China in particular.

In light of the recent crises and the emergence of a multi-polar world economy, the current International Monetary System is likely to evolve from its existing form to a more Multi-polar, Multi-currency System in which the U.S. Dollar would continue to play a notable role, albeit alongside other currencies which are likely to include the Euro and the RMB.

The existing International Monetary System goes back 100 years when the U.S. Dollar overtook the Sterling as a reserve currency when the United States had become the hub of industrialization and international trade for the western world.  The Dollar was also backed by Gold which made the selection easier.  The United States was able to retain the coveted international Reserve Currency status for the greater part of the last one hundred years by providing the users of its currency with open access to deep, broad-based, and liquid capital markets with low transaction costs and unfettered confidence of the global community.

However in recent years, the Global Financial Crisis has shaken the confidence of the international financial community.  This erosion of confidence has resulted in Central Banks re-visiting their strategies.  Strategies that call for allocating their reserves in liquid, less volatile, and diversified currencies that possess depth and breadth in the global markets.  That is precisely what is advocated under the Black-Litterman model that calls for investments to be allocated into different asset classes and geographically diversified. The RMB represents that solution to mitigate the inherent risks faced by all Central Banks in recent years.

As economic and financial reforms continue in China, the RMB has already begun to play a much more prominent role on the world stage.  The first channel is through trade settlement and secondly, RMB denominated products have increased offshore exponentially and policy makers are opening up its large domestic financial markets to foreign investors.

Let me highlight how the RMB has begun to go global evidenced by the following milestones:

1. According to SWIFT which monitors currency flows, the RMB in 2014 overtook the EURO to become the second most actively used currency to settle Trade Finance payments after the U.S. Dollar.
2. As of January 2015, the RMB became the 5^th largest payment settlement currency, marginally behind the Yen. I believe it will become the 4^th in the coming months, behind the U.S. dollar, Euro, and Sterling.
3. More than 10,000 financial institutions are doing business in RMB, up from 900 in 2011.
4. The offshore RMB Bond market has doubled in size each year since 2008.
5. Since ICBC Singapore was designated in 2013 as the RMB Clearing bank, 37 Trillion RMB volume was settled in 2014 in Singapore alone.
6. From just 3% in 2010, the RMB is now used to settle approximately 20% of China’s total trade.
7. Twenty-Nine (29) Currency Swap Agreements (CSA) valued at RMB 3.3 Trillion (U.S. $534 Billion) have been signed by PBOC with other countries to support trade in RMB.
8. Fifty (50) Central Banks and Sovereign Wealth Funds have signed Agency Agreements with PBOC to invest in Chinese onshore Bond market, evidencing confidence and trust in RMB on a global basis.
9. The U.K. Government, in October 2014, issued a RMB 2 Billion bond to add to the Bank of England Reserves, the first ever issued by a western country, a tacit endorsement of the RMB as a convertible reserve currency.

The above clearly demonstrates the success of the second largest economy in the world in making huge strides towards a formal recognition of the RMB as a freely convertible currency by the IMF.  Anecdotal evidences also suggest almost 1% - 5% of the reserves of central banks have investments in RMB and I can confirm that the State Bank of Pakistan invested in excess of 5% of its reserves in RMB in 2013.

One definition of a freely usable currency to qualify as a reserve currency includes:

1. At least 1% of a member country’s official reserves holdings are invested in that currency and,
2. At least 3 of the member countries reporting a currency that meets the first threshold.

Once again, the above clearly demonstrates and fulfils the eligibility of the RMB in the IMF basket of qualifying currencies.

Earlier I had mentioned that Public Trust is at stake and the Global Financial Crisis has shaken the confidence of the financial markets.  It behoves the Central Banks and Policy makers to take collective action to restore the International Monetary System’s confidence by including the RMB in its rightful place as a Reserve currency that would help resolve the global imbalances, lower capital flows and FX fluctuations that we have seen recently.

In conclusion, the current system with all its flaws was relevant for a very long time and still has roots.  The time has come for a coordinated shift towards a balanced Multi-Currency Reserve Management System.  The System provides alternatives to Central Bank Reserve Managers for diversifying foreign exchange currency holdings and is consistent with a multi-polar world.

The Internationalization of the Renmimbi and its greater role in the International Monetary and Reserve Management System has been a growing theme and given the growing size of the Chinese economy as well as its status as the world’s largest exporter, it seems only natural that the Renmimbi takes its place as an international reserve currency.

Thank you.

Yaseen Anwar

Senior Adviser, ICBC

(Former Governor-State Bank of Pakistan)