RMB's SDR inclusion revs up globalization
- By He Yafei
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E-mail China Today, March 18, 2016
The RMB's SDR inclusion is expected to contribute to the international monetary system in terms of stability, representativeness, and legitimacy. For example, currencies in seven East Asian countries now have closer ties with the RMB than they do with the U.S. dollar. When the RMB appreciates by one percent, the currencies in these seven countries appreciate by 0.55 percent. However, if the U.S. dollar appreciates at the same rate, these currencies rise by just 0.34 percent.
What's more, the RMB's SDR inclusion facilitates China's financial reform, which will boost the RMB's competence in the global market. This demonstrates China's resolution in carrying forward its financial reform, notably opening-up of its capital accounts. Financial reform has always been an important part of the pilot moves carried out in the free trade zones in Shanghai, Fujian, Guangdong, and Tianjin.
According to IMF officials, China is changing its exchange rate system from that of pegging the RMB to the U.S. dollar to one that is more open, flexible and market-based. The RMB is expected to float freely in the coming two or three year. Even though at this stage we cannot guarantee this will be fulfilled, there is no doubt that reform of the financial system will not cease and that it will advance in three facets. First, by relaxing restrictions on the issue of RMB bonds and supporting issuance by government bodies and domestic enterprises of RMB bonds abroad. Second, by promoting two-way opening of the stock market while allowing overseas companies to carry out equity financing in China's inland, and encouraging qualified individual investors to invest abroad. Last, by improving the global RMB payment system after it comes into effect.
Internationalization of the RMB sped up remarkably in 2015. According to a report issued by the Society for Worldwide Interbank Financial Telecommunications (SWIFT), at the end of August 2015, the RMB had surpassed the Japanese yen to become the world's fourth-largest payment currency. SWIFT statistics show that the RMB's global payment market share was 2.79 percent, that of the U.S. dollar was 44.82 percent, that of the Euro 27.2 percent, the British pound sterling's was 8.45 percent and the Japanese yen's 2.76 percent. On top of that, the RMB has become the second most used currency in trade finance. Moreover, a currency in the SDR basket is a foreign exchange reserve asset for other countries. Therefore, the RMB will showcase the significant influence of being a reserve asset.
First of all, many countries have used RMB as part of their reserve currencies. But the total quantity is not yet immense. Being included in SDR basket, however, will undoubtedly increase the RMB proportion in each country's reserve currencies, and stimulate the world demand for the currency. Standard Chartered and AXA Investment Managers estimate that by the end of 2020, US $1 trillion will be switched to Chinese assets.
Secondly, the inclusion bolsters confidence in China's economy and currency at the strategic level. Take the bond market as an example. Deepening financial reform in China brings positive influence on different facets of the bond market. Viewed from the medium-term, interest arbitrage will keep drawing overseas capital. But it will be removed in the long run by descending bond yields. Moreover, global investors venturing into the Chinese market may expand interest rate elasticity along with yield curve effectiveness. Besides, integrating credit ratings in China with international standards will help narrow the gap between the domestic and global rating systems.
Overseas investors occupy just 2.4 percent of China's bond market which has a total value of US $40 billion. However, the figure in India stands at 5.7 percent, in South Korea at 6.5 percent, in Thailand at 18.6 percent, in Malaysia also at 18.6 percent, and in Indonesia at 36.5 percent. China's potential and opportunities hence need to be dug out. Opening up the domestic bond market may slow down outflows of domestic and foreign capital, which is important at the current stage wherein the RMB may depreciate.
Strategic confidence will lead to a rising demand for RMB assets, and expand the gap between demand and supply, especially in investment and hedge funds. Bank for International Settlements statistics reveal that at the end of the second quarter 2015, outstanding global bonds and bills stood at US $20.67 trillion, 42.66 percent of which were priced in U.S. dollars, while 39.16 percent were priced in euros, 9.62 percent in British pounds sterling, and 1.95 percent in Japanese yen. With a weighting of 10.92 percent in the SDR basket, outstanding international bonds and bills priced in RMB take up around 10 percent, which means that a deficit of US $2 trillion currently exists in the market. This amount equals the sum of China's new bank loans in 2014 valued at RMB 9.78 trillion, and its new corporate debt financing worth RMB 2.42 trillion.
At present, the total the RMB's SDR quota is only US $280 billion, taking up 2.5 percent of global reserve assets. Whether a sovereign currency is a global reserve asset is judged by such criteria as the country's macroeconomic conditions, perfection of its financial system, and the openness of its capital market. The Canadian dollar and Australian dollar, although not included in the SDR basket, are global reserve currencies. Hence, SDR inclusion is only one of the symbols of the RMB's internationalization rather than its ultimate goal.
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