RMB IN SDR: WHY DOES IT MATTER FROM TRADE PERSPECTIVE?

Originally published on chenzhuoran.wordpress.com on Feb 14, 2016

On Monday November 30th,  the International Monetary Fund(IMF) announced that Chinese Renminbi(RMB) will be included as the fifth currency in the basket of the Special Drawing Rights, effective October 1st, 2016. The respective weights of the U.S. dollar, euro, Chinese renminbi, Japanese yen, and pound sterling will be 41.73%, 30.93%, 10.92%, 8.33%, and 8.09%. That’s without question a big milestone in the RMB’s journey of internalization, a journey that’s still far from the end. And this big leap of RMB gives rise to people’s speculation of how would this event influence China, the world largest exporter, in terms of trade.

IMF CHIEF HAILS RMB’S ENTRY INTO SDR BASKET

First of all, what’s SDR? The SDR was created by the IMF in 1969, the amount of SDR stands at 204.1 billion. There are no notes or coins denominated in SDRs, but the SDR does play a role as an interest-bearing international reserve asset. The IMF allocates SDRs to its members in proportion to their standing in the organization and the allocation of SDRs boosts member countries’ official reserves. Once the SDRs have been added to a member country’s official reserves, the country can exchange its SDRs for hard currencies through voluntary trading arrangements with other IMF member countries.

Problems have come: how would this event influence influence China, the world’s largest trading nation? How would other countries especially other Asian countries be affected? Will dollar’s dominance in international trade and finance be diminished? etc.

One thing to be sure: RMB would have a greater presence in global economy, strengthening the force of buying it long. For one, Nigeria has been keen on purchasing RMB from 2010, a time before China allowed other countries’ central bank to buy its bonds in Shanghai. In response, China limited the purchase of RMB and promoted the use of swap agreement under which China would keep the RMB until the other country need it for crisis use. However, now RMB has been recognized as one of elite international currencies which supposed to be “freely usable”, any policy protecting RMB against purchase, which did backfire China’s campaign for IMF reserve status,  would be put under a stricter scrutiny. As China’s capital market become more and more open, appreciation of RMB is expected under the potential capital tsunami. But China’s investors are also seeking to diversify their holdings so a capital outflow would offset the capital inflow to some extent. In the context of currency competition, since RMB’s weight in SDR is primarily from Euro, dollar’s share remains over 40% and its dominance would continue. “China is missing one crucial ingredient: the world’s trust,” states the report from Brookings. “To achieve currency dominance, China needs more than economic and military might; it requires a broader and more credible set of public and political institutions.”

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LAMIDO SANUSI, THE GOVERNOR OF THE CENTRAL BANK OF NIGERIA, SAID IN 2010 IT WAS READY TO PUT UP TO A TENTH OF ITS ENTIRE RESERVES INTO RENMINBI, OR $4 BILLION. CREDITTYLER HICKS/THE NEW YORK TIMES

A more internationalized RMB’s effect on China’s international trade is two-fold: on the one hand, as more and more countries weights more RMB in their foreign exchange reserve and as RMB is traded in a increasingly volume though bonds and other financial assets across borders, the general demand for RMB globally will be going up in the foreseeable future, which will put a lot of pressure on RMB to appreciate and make China’s exports less competitive, though this effect can be partially offset by the increase of China’s capital outflow at the same time. On the other hand, a wider use of RMB in international finance and trade would would increase the stability of RMB in case of exchange rate turbulence and the potential appreciation of RMB would make import goods cheaper.

This event’s effect on international trade may be profound, though may not necessarily be immediate. As half of China’s trade is processing relate–assembling parts and components from other Asian countries before importing them to the west, a greater use of RMB, which has already been used as “reference currency” by several Asian countries, would benefit other  Asian countries by improving trade efficiency and reducing exchange-rate risk in intra-regional trade. Also,Several countries have a trade deficit with China and they need the RMB, while many countries in Africa have a trade surplus with China, and have been accumulating RMB. So RMB’s addition to SDR will allow these countries to trade in the currency.

 

References:

http://www.imf.org/external/np/exr/facts/sdr.htm

http://www.nytimes.com/2015/12/01/business/international/china-renminbi-reserve-currency.html?_r=0

http://indianexpress.com/article/explained/simply-put-dragon-now-in-basket-how-will-sdr-change/

http://carnegieendowment.org/2015/12/04/renminbi-s-sdr-promotion-is-both-gift-and-burden-for-china/ims4

http://freebeacon.com/issues/report-chinas-currency-will-diminish-dollars-role-in-international-trade/

http://www.cnbc.com/2015/11/28/imf-expected-to-include-yuan-in-sdr-currency-basket.html

 

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