Insights into Editorial: An elusive quest to internationalize renminbi + MINDMAPS on Issues
05 December 2015
China’s Renminbi was recently inducted by the International Monetary Fund into its Special Drawing Rights (SDR) Basket alongside the dollar, euro, pound sterling and yen.
- This is being seen as a victory for Beijing’s campaign for recognition as a global economic power. The inclusion is a major boost to Chinese efforts to internationalize its currency. The inclusion is also a reflection of a changing world order.
- To meet the IMF’s criteria, Beijing had undertaken a flurry of reforms in recent months, including better access for foreigners to Chinese currency markets, more frequent debt issuance and expanded yuan trading hours.
How the inclusion has affected other currencies in the basket?
The inclusion Renminbi has changed the weightage of various other currencies in the basket.
- Renminbi will have a 10.92% share in the basket.
- The euro’s share has come down to 30.93%, from 37.4%.
- The weightage of sterling and yen have dropped to 8.09% and 8.33% respectively.
- The dollar remains broadly unchanged at 41.73%.
Global implications:
- Globally, the addition is likely to fuel demand for China’s currency and for renminbi-denominated assets as central banks and foreign fund managers adjust their portfolios to reflect the yuan’s new status.
- Most of the advanced economies and many others, including India, have large bilateral deficits with China. Others, primarily energy and commodity exporters, have surpluses. With the renminbi as a reserve currency, the latter group could enter into trade with the former in a global currency exchange. This would help create a genuine market, which is a critical requirement for a reserve currency.
Will the inclusion in the SDR make renminbi a preferred reserve currency?
Some experts are of the opinion that the inclusion of Renminbi will not automatically propel renminbi to a preferred reserve currency status. This is mainly because of the following reasons:
- China may be the third largest exporter in the world, but its currency contributes just about 1% of the total reserves held globally, according to IMF data.
- The use of the renminbi has increased in cross-border payments in recent years but that number is still a small fraction of the transactions settled in dollars or euros.
- Over the decades, the SDR itself has lost much of its relevance. It was created in 1969 in a fixed exchange rate era to complement gold and the US dollar as a reserve asset. But the collapse of the fixed exchange rate regime in the early 1970s and the subsequent development of financial markets have given countries the choice to accumulate reserves in different globally traded currencies.
- SDRs have a very limited role in the world economy. They can be held and traded only by central banks and a handful of other authorised institutions. They account for less than 3% of total central bank reserve assets. And they can easily be replicated by holding the constituent currencies.
Future of the Renminbi:
More than inclusion in the SDR basket, the future of the renminbi will depend on the opening up of financial markets in China. And there are serious doubts on this account.
- Although IMF has noted that the renminbi will become a freely usable currency by October 2016, which is one criterion for inclusion in the SDR basket, there are questions over the extent to which the Chinese government would be willing to cede control and allow market forces to play a greater role.
- China is currently in the middle of a structural slowdown, and is trying to engineer a shift from manufacturing-based, export-led growth to a more services-oriented economy. In a state where there are considerable challenges on the economic front, it is unlikely that the Chinese government would want to open up the financial sector in a hurry and induce more uncertainty.
Thus, to make Renminbi a preferred reserve currency globally, China will have to open up its financial market and let go of capital controls, which have been a pillar of the Chinese growth model. China should also build a robust regulatory architecture.
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