Rmb inclusion in SDR? It's just Esperanto

China is pushing for the renminbi to be included in the IMF’s accounting mechanism, but some suggest more financial reform is needed to raise confidence in the currency.
Akinari Horii
Akinari Horii

Christine Lagarde, managing director of the International Monetary Fund, has described the inclusion of the renminbi within the IMF’s internal accounting mechanism as a metter of ‘when’, not ‘if’.

But other than assuaging national pride, making the renminbi part of the IMF’s Special Drawing Rights (SDR) – a unit of accounting used solely to measure IMF transactions with central banks – will have no practical impact without greater Chinese reforms.

“There would be no practical benefit for China beyond pride,” said Akinari Horii, former assistant governor of the Bank of Japan and currently a member of the board of the Canon Institute for Global Studies. Horii said there is no scope for the private sector to use SDRs for payments, nor for retail or institutional investors to invest with SDRs.

Horii, speaking at a seminar organised by the Fung Global Institute and the University of Hong Kong, reminded the audience that the historian Charles Kindleberger once likened SDRs to Esperanto, the supposedly universal but inauthentic and unused language. “And it’s still that way,” he said.

The IMF will decide on whether to include the renminbi this autumn after China’s premier, Li Keqiang, officially requested it be added to the SDR bucket in March. Currently the SDR’s value is determined by a basket of US dollars, euros, yen and British pounds.

Giant steps
Helen Wong, chief executive for Greater China at HSBC, said the renminbi is becoming an important currency and may one day be regarded as a global reserve unit, along with the dollar and the euro.

She noted the People’s Bank of China (PBoC) has laid out a three-stage plan for internationalising the currency: using it for trade settlement, for investment payments, and ultimately as a reserve held by other central banks.

Many recent initiatives have been part of that ultimate goal, including offshore Rmb-denominated bonds, PBoC swaps with other central banks, Rmb-denominated qualified foreign institutional investment schemes, the establishment of a financial free-trade zone in Shanghai, Stock Connect and the announced mutual recognition for funds domiciled in Hong Kong.

In terms of trade settlement, the renminbi has made strides: in 2011 it accounted for 7% of China-related trade, versus 22% in 2014 and an estimated 30% for 2015, said Wong. Total direct investment flows denominated in renminbi, both outbound and inbound, climbed from Rmb110 billion ($18 billion) in 2011 to over Rmb1 trillion ($161 billion) last year, she added.

“The capital account is more open than many people realise,” Wong said. “Most items are now convertible or partly convertible,” while large pools of renminbi liquidity have gathered in Hong Kong and other offshore centres.

Not yet trusted
This progress is not enough to establish the renminbi as a desirable currency, however. Likening a currency to a brand name, Robert Aliber, an economist at the University of Chicago, said acceptance requires both Chinese reforms and international demand.

“If I’m the reserves manager at the sovereign fund of Norway or Kuwait, I need to be convinced that ownership of the renminbi will be rewarding,” he said.

Inertia is working against the renminbi today. The dollar, despite many US policy mistakes in recent years, retains the same position in currency trading volumes as before the global financial crisis. Aliber said this is more due to the networking benefits of the dominant currency, which makes it hard for other currencies to increase market share, at least for a while.

Aliber argued China needs to think about more than just its economic heft if it wants foreign reserves managers to embrace the renminbi. “Foreign reserves managers need to ask themselves, if they have a dispute with a Chinese bank or broker, how does that get resolved?” Aliber said. “Will the Chinese justice system give me a fair hearing? China needs to take measures to improve foreigners’ trust.”

Sounding a similar note during a recent visit to Hong Kong, former US Fed chairman Ben Bernanke said China should work on sustainable economic growth rather than push prestige projects like the internationalisation of the renminbi.

How internationalisation of the renminbi fits in with China’s slowing economy and transition toward a more domestic, consumer and innovative model must also be considered, he said. In other words, is China better served by trying to become a reserve currency, or by devaluing the renminbi?

Misguided ambition?
But the biggest question China’s policymakers should ask is whether the benefits of being a reserve currency are worth the costs, Aliber said. The dollar’s status as a reserve currency means the US may need to bear the pain if Europe and Japan seek to defeat deflation by depreciating their currencies, at the expense of US employment and fiscal strength. “That’s something for China to ponder,” he said.

Horii said the renminbi is too immature to warrant inclusion in the SDR basket, even if other countries decide to admit it for political reasons.

For example, the renminbi is still only 2.2% of the $5.3 trillion global foreign exchange trading volume – and that is based on a market total of 200%, because each trade needs a counterparty. (The dollar is 87%, the euro is 33% and the yen is 23%.)

Other emerging markets enjoy similar market share as the renminbi, such as the Mexican peso (2.5%). Other units are more important: the Canadian dollar and Swiss franc enjoy double the renminbi’s volume, and the Australian dollar is traded four times more, Horii said.

Until Chinese authorities embrace free and full liberalisation of the capital account, Horii said China’s financial markets won’t be sufficiently developed, and international financial market players won’t have full confidence in the renminbi. Confidence in the currency requires confidence in its operations as a means of accounts and payments, as well as a method of payments and provider of liquidity, backed by a trusted and transparent legal system.

Until then, despite the real strides the renminbi has made, making it part of the IMF’s SDR basket may give China a symbolic boost – but it’s all still Esperanto.


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