by On November 30, the International Monetary Fund invited the renminbi to join the pound, euro, U.S. dollar, and yen in an exclusive club of international reserve currencies starting in October 2016. China has been working to make its currency a credible global player for at least two decades, and the nod from the IMF is a significant symbolic victory. Still, don’t expect central banks to scoop up mass quantities of renminbi just yet. Central banks currently hold only about one percent of their .8 trillion in foreign exchange reserves in renminbi. Credit Suisse thinks banks will add somewhere between 0 billion and 0 billion worth of the Chinese currency to their stockpiles over the next two years, with an outside chance of substantially more, up to 0 billion or so. That would bring the renminbi up to just 2.5 percent to 3 percent of total reserves, but capital inflows into China from central bank governors diversifying their holdings by adding renminbi would be useful in other ways – namely by offsetting China’s accelerating outflows and reducing the risk of another devaluation like the one in August. There are a number of reasons central bankers are unlikely to be loading up on Chinese currency right away. For starters, they have no obligation to do so.
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Ashley Kindergan considers the following as important: Central Banks, China, currency, IMF, renminbi, Reserve Currency, SDR, Special Drawing Rights, World Affairs: Features, Yuan
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On November 30, the International Monetary Fund invited the renminbi to join the pound, euro, U.S. dollar, and yen in an exclusive club of international reserve currencies starting in October 2016. China has been working to make its currency a credible global player for at least two decades, and the nod from the IMF is a significant symbolic victory. Still, don’t expect central banks to scoop up mass quantities of renminbi just yet.
Central banks currently hold only about one percent of their $7.8 trillion in foreign exchange reserves in renminbi. Credit Suisse thinks banks will add somewhere between $150 billion and $200 billion worth of the Chinese currency to their stockpiles over the next two years, with an outside chance of substantially more, up to $780 billion or so. That would bring the renminbi up to just 2.5 percent to 3 percent of total reserves, but capital inflows into China from central bank governors diversifying their holdings by adding renminbi would be useful in other ways – namely by offsetting China’s accelerating outflows and reducing the risk of another devaluation like the one in August.
There are a number of reasons central bankers are unlikely to be loading up on Chinese currency right away. For starters, they have no obligation to do so. The IMF included the renminbi in the basket of currencies that comprise its Special Drawing Rights (SDR) reserve asset, which the fund issues to countries to shore up their reserves. Countries can exchange SDRs for a reserve currency, trade them with other central banks, or use them to repay IMF debt. Central banks could base their reserve holdings on the weighting of the SDR basket, but they don’t have to, and in practice they rarely do.
Central bankers also tend to maintain currency reserves in proportion to their actual use. The renminbi was the fifth most used currency in the world in September, accounting for 2.5 percent of global transactions. In 2016, Credit Suisse sees a slight increase, estimating that 3 percent of global transactions will take place in renminbi – in line with their prediction that the currency will only rise to about 3 percent of total reserves, rather than the double-digit proportions other analysts have predicted.
Central banks also favor maintaining reserves of the currencies of their biggest trading partners, but they aren’t likely to hold renminbi in direct proportion to Chinese trade volumes. That’s because China settles just 30 percent of its trade in renminbi, compared to the 90 percent of American trade settled in dollars and 70 percent of Japanese trade in yen.
Central bankers do keep currencies around to pay down foreign debts, but China accounts for just 0.6 percent of international debt securities and an even lower proportion of international banking liabilities. With China leading the Asian Infrastructure Investment Bank and the “One Belt, One Road” infrastructure program, those numbers will eventually increase – but not for several years.
Central bankers also have to assess the merits of the currency itself. On one hand, the renminbi has appreciated significantly against most other currencies since 2010, and Credit Suisse believes China’s strong current account surplus, low inflation, and relatively high growth means it will continue doing so. On the other hand, there are risks to holding large quantities of renminbi, as both the fixed income and currency markets in China are relatively illiquid. China allowed foreign investors easier access to the onshore bond market this summer, but trading levels are still very low. In government bonds, too, state banks account for 80 percent of daily trading. In the currency markets themselves, while the government allowed market forces to play a larger role in determining the renminbi’s value this August, policymakers still intervene frequently. Credit Suisse says central banks have been reluctant to increase their renminbi holdings for fear that the government might suddenly halt trading in either the currency or Chinese bonds.
This last reason that central banks may remain wary of the renminbi – skepticism about the Chinese financial system – is where the SDR may have long-lasting effects. Inclusion in the SDR obligates China to allow other central banks to “freely use” the currency, and Credit Suisse believes the IMF stamp of approval may give more private investors the confidence to venture into Chinese debt markets. Credit Suisse believes that reserve-currency status will encourage official reforms that further open the capital account and make the financial system more transparent. It was reforms of that exact sort that played a key role in the IMF’s decision to add the renminbi to the SDR, and after years of vying for a spot on the global financial stage, China seems unlikely to want to jeopardize its newfound status.