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China to take a global step forward

By GILES CHANCE (China Daily) Updated: 2015-05-25 10:42

China to take a global step forward


Membership in the elite reserve-currency club beckons, but it brings with it some obligations

Just when we were getting accustomed to China's diplomatic success in bringing Europe and Asia together to launch the Asian Infrastructure Investment Bank, along comes another big test of China's position in the global pecking order.

Next month the International Monetary Fund in Washington will consider if there should be any changes in the composition of the Special Drawing Rights, a synthetic currency the IMF created for issue to central banks. This review comes every five years, and although changes can be made within the five-year time frame, it would be highly unusual to revisit the subject before 2020. The SDR is composed of the dollar, euro, British pound and Japanese yen, with the dollar and euro making up 72 percent. The key issue that the IMF board will be considering is whether the Chinese currency should join the other four currencies as a global reserve currency.

Although the IMF will not announce its final decision until October, by the end of next month an idea will be forming of the renminbi's chances this time.

Global reserve status means that a currency takes on a special position in the global financial markets as a store of value to investors, as a unit of measurement for multinational balance sheets and as a currency used in international trade. Investors would feel comfortable holding their assets in the currency, because they believe that its value will be maintained, and their assets can be accessed cheaply and easily. So the currency has to offer a high degree of convenience and safety to international traders and investors. These characteristics in turn strengthen the currency's appeal to its own people.

The currency markets have long memories and are very conservative. The British pound ceased being the dominant currency in the world nearly a century ago, and although the United Kingdom economy does not have the important global position it once had, the pound is still one of the four global reserve currencies.

It is not easy for the renminbi to become a reserve currency. But if it happened, it would have major consequences for China's position in the world. The global equity index, the Morgan Stanley Capital International Index, will include the Chinese onshore equity market, valued at about $9 trillion which makes it the world's second-largest, after that of the United States. The Chinese mainland's share of the global equity index would rise from about 2.5 percent to more than 10 percent. A large proportion of global equity investment is made through funds fixed to the MSCI index. Funds have to match index changes. With the MSCI index accounting for $48 trillion of global equity capital, index changes would bring several trillion dollars worth of investors' money into China, likely reducing Chinese interest rates.

Over the longer term, China's capital markets would become much more closely linked to the rest of the world. The Hong Kong-Shanghai Stock Connect program, which started in November, and the Shanghai free trade zone have already started this process. The inclusion of the renminbi as a member of the SDR will accelerate it significantly.

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