Small step for money, giant leap for world

The renminbi's entry into special drawing rights represents the first time a currency of a developing country has become a de jure reserve asset, an official recognition of a momentous shift in the global power balance.

The SDR is the International Monetary Fund's artificial composite currency unit, part of the glue that binds world finance, but with no real role in international markets. This is a small step for money, but a giant leap for the monetary system.

The IMF executive board's ruling on Nov 30 in Washington that the renminbi is "freely usable", and thus can be included in the SDR from Oct 1 (despite the persistence of some Chinese capital controls), has geopolitical implications.

Acquiescence by the United States in this landmark move is recognition that China's march to the top table of the world economy is unstoppable. Yet confirmation of a multi-currency reserve system - under which the renminbi joins the dollar, the euro, the yen and sterling as a reserve asset - could herald considerable fragility as the world monetary system moves in the next few years to a new modus operandi.

The vote by the IMF to make the renminbi the fifth currency in the SDR basket follows a relatively short, well-orchestrated campaign by the Chinese authorities to promote recognition. The renminbi will become the third-biggest currency in the SDR basket from October.

Christine Lagarde, IMF managing director, called it a major milestone in China's economic reform journey.

The inclusion of the currency marks the most significant change in the IMF's basket since the euro replaced the German mark and the French franc in 1999. The dollar will remain the biggest currency with a 41.7 percent weighting, followed by the euro with 30.9 percent. With a 10.9 percent share, the renminbi moves beyond the yen (8.3 percent) and sterling (8.1 percent).

The move has limited significance for the use of the SDR in private markets. For the SDR to gain momentum in borrowing and investment, it would need to become a currency in its own right, similar to the development of the European currency unit, used in the bond markets from the late 1970s onward. The unit's bond deployment accelerated in the '90s as the countdown to its transformation into the euro got underway. An analogous change for the SDR looks unlikely.

A more likely bond market beneficiary of a wider SDR is the renminbi itself. In the short run, the decision may prompt a further $100 billion (94.3 billion euros) worth of official buying of yuan-denominated assets. Longer term, the figure could be much greater, raising the question of how supply of good-quality renminbi assets could be increased to meet this extra demand.

In contrast to the artificial SDR, the renminbi is becoming much more real for investors around the world. Approval of the renminbi's inclusion is of enormous symbolic value to Beijing, reinforcing its bid to turn the renminbi into an international hard currency and to challenge Western dominance of global monetary governance. More specifically, it could trigger a large shift of global institutional assets into renminbi.

Already, the renminbi has become a de facto reserve currency. Going by rough calculations, there may be about $100 billion of renminbi reserves in central bank holdings, about half the total held in Canadian and Australian dollars, according to IMF estimates. On this basis, SDR inclusion could spark a further $100 billion worth of renminbi purchases by central banks.

This is not a huge figure compared with the Official Monetary and Financial Institutions Forum's estimate of global official sector assets of $30 trillion, and a daily foreign exchange turnover estimated by the Bank for International Settlements at $5.3 trillion. But shifts of this nature could be a milestone event, especially if similar movements follow in the private sector.

The overall renminbi bond market, including both public and private sector debt, is estimated at about 35.9 trillion yuan ($5.6 trillion; 5.2 trillion euros), according to Goldman Sachs, making it the third-largest in the world after the US and Japan.

There may be a shortage of yuan-denominated investable assets for world central banks in coming years. Chinese government borrowers are unlikely to generate significant additional issuance, so part of the demand from worldwide central banks may have to come from renminbi issuance by top-rated agencies such as the World Bank and sovereign governments, where the British government gave a lead last year with a 3 billion yuan issue.

One important implication of the SDR move is that there will be more such bonds from Western governments in coming years.

The author is the managing director of the Official Monetary and Financial Institutions Forum.

(China Daily European Weekly 12/04/2015 page7)