Since Deng Xiaoping embarked on market reforms in the late 1970s, China has evolved from a poor, closed economy to become first the factory of the world and now a country on the cusp of significant economic opening.
This begs the question of how the Chinese currency, the renminbi (RMB), will integrate into the global financial system.
It is a matter of when, not if, the RMB will be included in the International Monetary Fund’s (IMF) Special Drawing Rights (SDR) currency basket. With the five-yearly SDR review due later this year, I think now is a good time.
To qualify, the RMB needs to be ‘freely usable’, though not necessarily ‘fully convertible’
The RMB’s inclusion would cement its rising reserve-currency status and accelerate investment in the currency. To qualify, the RMB needs to be ‘freely usable’, though not necessarily ‘fully convertible’. The yen became fully convertible only in 1980 – two years after the IMF determined it to be freely usable.
Sceptics may focus on how far China still has to travel, but instead I would urge the IMF to look at how far it has come.
RMB’s international rise
The RMB is the world’s fifth most-used payment currency, according to SWIFT, and 27 per cent of China’s total goods trade is now settled in RMB.
Onshore, the Shanghai Free Trade Zone spearheads pilot tests for China’s capital account liberalisation, including the ‘two-way RMB sweeping’ programme.
Offshore, RMB centres led by Hong Kong, Singapore and London now provide a wide range of RMB hedging and investment products, plus access to raise capital in the ‘dim sum’ bond market worth a staggering CNY750 billion.
Foreign investors are enjoying increasing access to China’s stock and bond markets, and the RMB foreign exchange market has become considerably deeper and more liquid.
The RMB is already a recognised currency in the eyes of many central banks
Also, more than 60 central banks globally have invested in RMB assets, with estimated holdings of over USD100 billion. So the RMB is already a recognised currency in the eyes of many central banks. According to the People’s Bank of China (PBOC), the RMB now ranks seventh in reserve holdings globally.
To me, all this suggests the RMB broadly meets the technical requirements based on the current ‘freely usable’ SDR criterion. It should also count in the RMB’s favour that China is beginning to exert its geopolitical influence on the global stage, starting with its leading role in establishing the Asian Infrastructure Investment Bank.
Does that mean China can’t do more? Of course not.
China still has work to do
For one, China still imposes foreign exchange controls on personal capital transactions. And foreign investors still don’t have sufficient access to Chinese capital markets.
But it would be a mistake to doubt Beijing’s political will to deliver greater convertibility. PBOC Governor Zhou Xiaochuan recently vowed to launch a series of reforms in 2015, including pilots to allow individuals to invest directly overseas –starting with the impending launch of the QDII2 scheme. And just days ago, the mutual recognition of funds between China and Hong Kong was announced.
A steady, managed emergence into the global economy is good not only for China but for the rest of the world
Zhou said China aims for ‘managed capital account convertibility’ rather than the traditional concept of ‘full’ or ‘free’ convertibility. This means that China will retain capital account management in some areas, including external debt and short-term speculative capital flows.
While critics may pounce on this as showing lack of commitment, I believe it is a positive. China is pursuing a more sustainable growth model through serious reforms. Doing so while liberalising from a closed to open economy is a tough balancing act and potentially destabilising, if not handled with care.
A steady, managed emergence into the global economy is good not only for China but – but given the country’s sheer size and global influence – for the rest of the world.
The IMF is pivotal
As we continue to hold our collective breaths for the final outcome of the SDR review, the IMF should be aware of the risk that, without legitimacy in the form of SDR inclusion, the global expansion of RMB usage could become increasingly straight-jacketed.
The role of the IMF is not just to foster currency and monetary development, but also to secure financial stability and promote sustainable economic growth. Right now, the IMF is instrumental to China’s further opening – a potential catalyst for its future liberalisation and next phase of economic and financial development.
I believe the RMB deserves its SDR recognition, and the world deserves a sustainable Chinese economy and the continued global emergence of its currency.
This article was first published in South China Morning Post on 08 June 2015