1. In your opinion, what is the chance of the RMB to join the SDR basket this year? Has it met all the criteria? What is the biggest barrier preventing it from joining?
The probability that the RMB will join the SDR basket this year is now high. It should be considered the consensus expectation. According to the IMF’s technical rules, such a currency must fulfill two requirements. First, it must represent a major trading nation. Today, China is the world’s leading trade engine. Second, it must be “freely usable” (not necessarily fully convertible). Reportedly, China’s measures to accelerate capital account convertibility have has been adequate to the IMF whose staff and chief Christine Lagarde recently endorsed the inclusion of the RMB.
However, the second step of the inclusion requires a political decision. In the IMF board, the RMB needs a 70% majority in the final vote to become a reserve currency. That is now reachable. Major European economies support the decision and so does the US (though conditionally).
If there is a major barrier still against the RMB’s inclusion, it would be more political than economic by nature.
2. What difference would it make to the rest of the world if the RMB is included in the international reserve currency? Also, what are the pros and cons of it.
Even if the IMF does not endorse the RMB’s inclusion, two scenarios remain. Either the IMF will have another vote in fall 2016, which would mean a year’s delay, or it won’t vote until its next official review meeting in 2020. Currently, both scenarios are less likely. The longer the inclusion decision will take, the less need there will be for Beijing to accelerate financial reforms, which would not be in the interest of the IMF or the major G7 nations (US, EU, Japan). Most importantly, as the IMF already supports the decision and China is a major trading nation, the RMB’s absence from the SDR basket would contribute to increasing doubts among emerging and developing economies about equity and representation in multilateral international organisations.
The inclusion is vital to both China and the rest of the world. Today, the world’s allocated foreign-exchange reserves amount to more than $6.1 trillion. Of the total, some 90 percent is dominated by the US dollar, the euro, UK pound, and the Japanese yen. Yet, China alone is fueling over 30% of global growth in which emerging economies are playing an increasing role overall, whereas the role of the advanced economies is steadily eroding.
The current stagnation in the West is amplifying the trends. The ongoing meltdown of the petro-dollar arrangements, which originate from the 1970s, is contributing to the same trends. Yet, while emerging economies are driving global growth, they are forced to use advanced economies’ currencies in international transactions. That is simply and plainly unsustainable.
3. Who would be the largest beneficiary if the RMB is included in the international reserve currency?
It is a win-win. Both the world economy and China will gain, when the RMB is included in the international reserve currency. On the one hand, advanced economies have for years sought greater access to the Chinese financial sector. With accelerated financial reforms in the mainland, this will become increasingly possible in the future. Conversely, Chinese RMB investors need greater access to international financial markets. That, in turn, is vital to support Beijing’s efforts to rebalance the economy toward consumption.
Furthermore, institutional investors in both China and worldwide are struggling to diversify risks and to gain greater yields. In brief, international investors need RMB assets; and their Chinese counterparts require non-RMB assets.
4. If IMF does/does not approve the RMB’s status this year, how would China respond, and what impact would it make on China’s economy? Will China devalue the RMB soon after IMF’s SDR inclusion?
A speedy RMB inclusion by the IMF would support China’s greater reliance on international financial institutions. Consequently, it would accelerate financial reforms in China, and thus faster capital convertibility. In a reverse case, the acceleration of reforms could slow in China. Moreover, a delay would also strengthen critical voices in China and other emerging and developing economies, which feel that international multilateral organisations work mainly in the interests of the advanced economies only.
In the short term, an IMF decision to defer the RMB inclusion would not have a critical impact on the Chinese economy. Since it would defer market-driven reforms, which add to volatility in the short term, it might even lessen current volatility. But in the medium-term, it would harm China’s economic strength, resilience and sustainability – and due to China’s increasing role in the world economy, it would cause a deepening self-inflicted would in global growth prospects.
Currency valuation issues involve periodic and short-term volatility in the short term, but are clearer in the medium and long-term. Currently, the RMB is seen as somewhat overvalued in the markets. The US dollar is about RMB 6.40. As the Fed is likely to hike the rates soon, that will strengthen the US dollar, which will translate to lower RMB. However, the real story is not so much whether China will devalue or not; rather, it is that, as China’s financial and currency reforms accelerate, the RMB will be more exposed to market pressures. In the short term, that may increase volatility periodically or occasionally; in the medium-term, though, RMB inclusion will make Chinese growth stronger, more resilient and more sustainable.
5. Do you think China is ready to supply the rest of the world with RMB?
For all practical purposes, China will gain from three phases of capital inflows. First, the composition of the IMF basket will shift, which could unleash $40 billion into RMB assets starting in October 2016 and gradually over the next half decade. Next, public investors (central banks, reserve managers, SWFs) are likely to mimic the IMF’s allocation shifts. That could translate to another $350 billion into RMB assets in the next half decade. Finally, and most importantly, institutional and individual investors will come to play an ever-increasing role, which would mean at least $40 billion annually to RMB assets by 2020.
So, yes, China is ready, able and willing to supply the rest of the world with the renminbi. After all, the rebalancing of the Chinese economy requires greater financial stability. The long-term health of Chinese markets, in turn, needs greater foreign participation. The greater strategic role of China in world affairs is also reliant on the RMB’s gradual expansion. There are many reasons that speak for and support the steady broadening and deepening of RMB assets.
About the Author
Dr. Dan Steinbock is an internationally recognized expert of the nascent multipolar world. In addition to advisory activities, he is Research Director of International Business at India China and America Institute (USA) and Visiting Fellow at Shanghai Institutes for International Studies (China) and the EU Center (Singapore). He was born in Europe, resides in the US and spends much time in China and Asia. For more, see www.differencegroup.net
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Image Courtesy of International Monetary Fund from Flickr: https://flic.kr/p/qNU4zg
