Back in 2009 the west was desperately seeking green shoots of recovery and paid little attention when Zhou Xiaochuan called for nothing less than a new world financial order.
China’s central bank governor proposed replacing the dollar as the international reserve currency with a global system controlled by the International Monetary Fund. If, as expected, the IMF this month approves the inclusion of the renminbi as a reserve currency, it will mark a small step for Mr Zhou’s 2009 vision but a big move for the renminbi.
The prospect of China’s currency joining the dollar, euro, yen and sterling in backing the IMF’s Special Drawing Rights — its unit of account, restricted to member governments — has been described as everything from a symbolic ego trip on the part of Beijing to the dawning of a new era.
In all probability it will be like many Chinese financial reforms: significant in hindsight, but hard to get excited about in the short term.
The gap between onshore and offshore renminbi rates has risen recently, suggesting less response by the People’s Bank of China to what the market, via the offshore rate, is implying
Market enthusiasm for early-stage reforms such as de-pegging the renminbi 10 years ago has given way to ennui as the changes get smaller and China gets bigger. The result is often disappointment in the numbers as China maintains an antipathy to the sweeping changes, accompanied by headline-grabbing figures, beloved of newly installed western executives and politicians.
Even the Shanghai-Hong Kong Stock Connect, a year old this week, was shrugged aside by many, because the absolute numbers involved are relatively small. However, its real significance lies in the fact that it was the first scheme under which foreign investors had been allowed in ‘blind’ — without requiring individual approval.
SDR inclusion risks being categorised the same way. That would miss the point. It is not about boosting short-term demand from central banks for renminbi. Rather it is about embedding the currency in the international system and committing Beijing to financial reform.
If China were to constitute up to 10pc of the SDR basket, reserve managers would need to buy just $28bn of its currency — not a particularly meaningful number compared with the $20bn traded daily in the onshore spot market.
Reserve figures are thus another source of headline number dismay. If China were to make up 3pc of the $11.5tn of reserves held globally by the end of 2016, as forecast by DBS economist Nathan Chow, that $340bn would vault the renminbi into the top league alongside sterling and the yen. Yet the dollar makes up almost two-thirds of reserves, and the euro 20pc.
Numbers aside, the big ramifications of SDR inclusion come from its effect on financial reform. Xiangrong Yu, economist at CICC, likens it to the impact of China joining the World Trade Organisation in 2002. “Even if the renminbi fails to be added this time around, it will be impossible to reverse these reform measures,” he adds.
Changes so far include the scrapping in July of the need for central banks and other sovereign-linked players to gain approval to invest in onshore bond markets. After all, reserve managers that want to add renminbi, however slowly they do so, will need assets to buy. And China likes and needs long-term, steady investors.
There are also the efforts to allow the currency to trade more in line with market movements — a goal of the mishandled August devaluation. The gap between onshore and offshore renminbi rates has risen recently, suggesting less response by the People’s Bank of China to what the market, via the offshore rate, is implying.
This, however, could be a function of the SDR campaign itself. After acceptance has been gained, pressure for a stronger currency should fade, paving the way for a drift lower.
For short-term investors the main outcome of inclusion could be greater uncertainty. For longer-term thinkers, it is possibly worth returning to Deng Xiaoping’s maxim describing China’s method of progress as ‘crossing the river by feeling the stones’. Investors sometimes need to count the stones felt and passed so far. There are more of them than the numbers involved suggest.
Published in Dawn, Business & Finance weekly, November 23rd, 2015
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