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Leap Forward For China's RMB As Currency Accepted Into IMF Basket; Wealth Managers React

Tom Burroughes

1 December 2015

This week the International Monetary Fund announced that its directors had voted to accept the Chinese renminbi into its currency basket system known as Special Drawing Rights, making it the fifth member currency (others are the dollar, euro, sterling and yen). The move represents a symbolic as well as concrete advance for the Chinese currency in achieving full international reserve currency status; it is in a stronger position to challenge the dollar for supremacy. Those chroniclers of so-called “currency wars” may see the IMF’s decision in this light although others will say the IMF is acting logically. China is now the second-largest economy in the world.

China has taken a number of steps to open up its capital markets in recent years; the path hasn’t always been smooth and investors in mainland China A-shares have been hit since August by a sharp fall in market values. As far as wealth management is concerned, there are likely to be further launches of RMB-denominated investment products in coming months and years, and centres such as London, New York, Singapore and Zurich will battle to win market share in forex trading in the RMB.

Announcing the decision, Christine Lagarde, IMF managing director, said: “The executive board's decision to include the RMB in the SDR basket is an important milestone in the integration of the Chinese economy into the global financial system. It is also a recognition of the progress that the Chinese authorities have made in the past years in reforming China’s monetary and financial systems. The continuation and deepening of these efforts will bring about a more robust international monetary and financial system, which in turn will support the growth and stability of China and the global economy.”

So now that the market has had a day to digest the news, we offer a selection of wealth managers’ reactions to the IMF decision.

Larry Cao, director of content, CFA Institute
For most investors, life does not change one bit on 1 December 2015. So you wonder, what’s the big deal? I think this is significant for two reasons. First, RMB has now been officially accepted into one of the most exclusive clubs in international finance. The club has only four other members: US dollar, euro, pound sterling and Japanese yen. Twenty five years ago when I started at PBOC as an intern, part of my job was to handle SDR transactions with the IMF. (To give you an idea how long ago this was, we did not have IDD at the time and we used rotary phones.) As all other member countries of the IMF, China committed to accepting the SDR. 

When IMF needs funding to implement its initiatives, it has the option of issuing SDRs to its members, which in turn will “buy” the SDR allocation with the reserve currencies in proportion to its percentage in the SDR or pay in any reserve currency at the market rate. Back then RMB was of course not a member of the SDR. The entire country had some twenty billion dollars in its reserves coffer. Each time we bought SDR we had to pay in US dollar, or some other SDR member currency that we think will drop against the dollar. (In fact, that’s how I got into the foreign exchange business.) Now any member of the IMF has the option of paying for SDR with RMB. 

The 10.92 per cent weighting RMB received in the SDR is the result of a new formula IMF adopted that takes into consideration each member currency’s importance in both international trade and international finance. I think the 10.92 per cent weighting properly reflects RMB’s status as a widely accepted and used currency international trade as well as its increasingly important role in international financial transactions. Second, joining the SDR has clearly served as an impetus behind some of the latest reform measures PBOC adopted; it will also help keep the RMB internationalization program on track.

As China rose to the top in international trade in recent years, it was natural for RMB to become much more widely accepted in the trading of goods and services. Where RMB fell short in IMF’s previous review was the “free use” criteria, most importantly, capital account convertibility. Twenty five years ago, when bankers travelling from Hong Kong and New York to Beijing seeking clarity on the issue of capital account convertibility, I always thought this was clearly going to happen one day. 

Chi Lo, senior economist, BNP Paribas
This should act as an external force, as well as a confidence booster, for China to push for further reforms, thus improving the structural underpinning for Chinese asset values. New reform efforts such as the expansion of the offshore renminbi market and further opening up of the onshore capital market by expanding the investment quotas and stock connect schemes is likely to proceed faster than other structural reforms that will take more time to implement. 

Foreign investors should, thus, have easier access to China’s onshore markets. More renminbi assets should also be made available in the offshore market. Being an SDR currency might also create a virtuous cycle where the anticipation of deeper renminbi internationalisation would prompt more central banks to hold the renminbi, which would then actually deepen its internationalisation and prompt more central banks to hold more of it. Global equity and bond indices may also include renminbi assets in their components, so international asset managers will have to include renminbi assets in their portfolios. However, the immediate impact on global portfolio decisions of the renminbi’s SDR status would not be as significant and as direct as an inclusion of Chinese A-shares in the MSCI indices. 

MSCI inclusion of Chinese stocks may not be immediate, but the international index provider has recently made an initial move by including Chinese stocks that are listed in the US stock market, such as Alibaba and Baidu, in its global emerging market indices. The short-term impact on the global economy and financial markets of the renminbi’s inclusion in the SDR is likely to be limited as the SDR accounts for only about 5% of global official reserve asset holdings.
Total SDR is equivalent to about $300 billion. Even if the renminbi were to be included in the SDR with a 10 per cent weighting (which would be similar to the weighting of the Japanese yen and pound sterling), the increase in central banks’ demand for renminbi via the SDR would amount to just $30 billion, which is negligible in global terms. 

After all, the SDR is not a currency, so adding the renminbi to the SDR basket will not have any material impact on international trade and financial transactions. Regarding the renminbi providing an alternative source of liquidity to global markets (for trade and investment purposes), this is still unlikely in the short-term. 

Bank of America Merrill Lynch
RMB's weight in the SDR basket will be 10.9 per cent, a bit lower than the preliminary estimates of roughly 14-16 per cent made by IMF staff in August. RMB inclusion in IMF's SDR is a milestone event recognising China and RMB's significance in the world economy.

The official endorsement of the RMB as a "freely usable" currency helps promote further international use of the RMB and encourages continued RMB convertibility and capital account liberalization, in our view. Having said that, we expect the direct impact on RMB and FX flows to be limited. Over the long term, it should help increase demand for RMB assets, if China continues to deepen its domestic bond market and continues its financial market reforms including capital account liberalization. In the coming months, to control capital flight risks amidst a weak economic backdrop, the PBoC will likely continue to carefully manage RMB expectations and keep its macro prudential measures to fight against possible speculative outflows.

RMB inclusion in the SDR may raise RMB inflows by $31 billion, given that the total allocation of the SDR is currently is $285 billion with RMB's weight at 10.9 per cent. This is a modest amount compared to China's FX flow magnitude. Moreover, related transactions are likely done between the PBoC and IMF members over several months, implying direct impact on RMB and FX market should not be material.

Over the long term, RMB inclusion in IMF's SDR may help increase demand for RMB-denominated assets from other central banks and global fixed income fund managers. 

Aidan Yao, Senior Emerging Market Economist at AXA Investment Managers (AXA IM)
Having an emerging market (EM) currency in the SDR will also improve the IMF’s representativeness in the global economy, as the political push for EMs to gain more voting rights has been repeatedly vetoed by the US congress. As for China, the IMF’s seal of approval is an important recognition of the growing importance of the RMB as an international reserve currency. We think today’s decision will encourage China to speed up RMB internationalization and the opening of the capital account – both will help China to continue to integrate its financial system into the world.

It is worth recognizing that, as a standalone event, the SDR inclusion does not bear much immediate significance. According to the new weighting calculation, the RMB will command a weight of 10.9 per cent – slightly below our prior estimate of 14 per cent, mainly at the expense of the euro and sterling. We estimate the rebalancing of the SDR portfolio will (only) drive an inflow of around $30bn over the span of a few years, and the process will not start until October 2016.