Briefing: Growing importance of the renminbi
Despite recent volatility, the Chinese currency’s role in international trade is growing fast, writes Joseph Mariathasan
China is attempting to have the renminbi included in the system of Special Drawing Rights (SDRs) run by the IMF. SDRs are an international reserve asset, created in 1969, to supplement its member countries’ official reserves. Its value is based on a basket of four key international currencies – the dollar, the euro, the yen and sterling.
The odds are that the renminbi will fail to be admitted to this exclusive club at the IMF’s five-year review later this year. Its capital account convertibility will probably be considered insufficient. But its achievement in meriting serious consideration is testament to its increased importance and internationalisation.
Indeed, Hayden Briscoe, head of Asia Pacific fixed income at AllianceBernstein argues the SDR debate is a sideshow to the renminbi’s internationalisation. “The Central Bank governor, Zhou Xiaochuan, has done a fantastic job in convincing President Xi Jinping that the renminbi should be included in the SDR but it doesn’t matter.”
The internationalisation of the renminbi is occurring at a breathtaking pace, says Briscoe. Nearly 25% of China’s trade is settled in offshore renminbi compared with almost nothing in 2009. “The currency already accounts for 9% of the global letter-of-credit market, ahead of the euro and yen and behind only the dollar. Its usage will expand to account for 50% of the country’s global trade settlements within just a few years,” he says.
Jan Dehn, head of research at Ashmore Investment Management, sees the creation of global reserve status for the renminbi as a key objective for China. In his view, it would convey three key benefits.
First, it could settle transactions in its own currency. This would dramatically reduce the requirements for foreign exchange reserves.
Second, China’s existing $4trn (€3.7trn) of reserves could be switched to return-seeking assets rather than sitting in US Treasuries. The recent establishment of the Asian Infrastructure Investment Bank is a conduit for this transformation.
Third, China could reduce its exposure to the dollar and US Treasuries.
A key step towards the final shift was taken in July when Beijing lifted all restrictions on the purchase of bonds by foreign central banks, sovereign wealth funds and supranationals. The significance of this is that it dramatically increases demand for Chinese sovereign debt by central banks and hence the status of the renminbi as a reserve currency.
Another key milestone for the internationalisation of the renminbi, says Briscoe, will be the outcome of the trade deals to be signed at the summit between US President Barack Obama and his Chinese counterpart in September.
Despite the rise of the renminbi, the dollar is likely to retain its position as the preeminent global reserve currency for the foreseeable future. As Grant Webster, a portfolio manager at Investec Asset Management, argues, one point of holding reserves in dollars is to act as a counterweight to the economic vulnerabilities faced by the country. Replacing the dollar with an emerging market (EM) currency, even the renminbi, may not serve a country well in times of trouble.
This insurance aspect of reserve currencies was also highlighted by Ricardo Adrogué, the head of EMD at Babson Capital Management, and his colleagues in a recent research paper. Based on simulations, it finds that adding liquid EM currencies, particularly the renminbi and inflation-linked bonds, would improve performance in normal times. However, official institutions holding the conventionally defined optimal portfolio of currencies would outperform a purely dollar-based portfolio over time but at the expense of experiencing greater volatility at times when such volatility is least desirable.
It takes about a decade for returns for the optimal portfolio to catch up to the safe portfolio following the maximum drawdowns during crises. Central banks are not going to relinquish all their dollars, if only because they need to have the insurance of a safe haven in times of crisis. What is likely to happen though, says Briscoe, is that central banks will be allocating between 5% and 25% of their foreign exchange reserves to the renminbi. The higher figures are likely to be reached in Asia, where countries have strong trading links with China, and with Latin American commodity producers.