Earlier this month, China launched another round of talks with its International Monetary Fund (IMF) counterparts to see to what extent it had fulfilled the required range of policy and market efficiency to qualify as a global reserve currency. The group, highly selective, constitutes close to 95% of the international turnover in currency trades annually. While this latest round was not conclusive, stomped by a few technicalities according to US Secretary Jack Lew, it is increasingly clear that China is as close as any other emerging market currency has ever been to being a global reserve currency. SDRs (Special Drawing Rights) are IMF-managed baskets of globally established currencies that can be held as reserves by central banks . How did China’s Renminbi (RMB) come to achieve its preeminent status, and what does that mean for the future of international foreign exchange markets?
China began to standardize and optimize the renminbi in order to join in the group of Special Drawing Rights’ included currencies in the early 1990s. At the time, Zhou En Lai, the noted reformer of Chinese economic strategy had just died. His successor, Premier Zhou Rongji, was keen on keeping his country on track for the momentous internationalisation of China’s labor and rare earth metals market into the global economy.
One of the first overtures to western internationally competitive financial institutions occurred when Premier Zhou Rongji summoned the heads of Goldman Sachs and Morgan Stanley, both investment banks, to oversee the task of making China’s then state-run economy into a competitive one, better in touch with the complexities international trade. Calibrating China’s currency to its export-heavy international trade orientation was one of their first priorities, in 1994.
25 years of double-digit GDP growth later, China has successfully internationalised its currency, this as a result of effective monitoring and macroprudential scrutiny targeted to stabilize its price at specific levels, depending on the 5-year plan. It now boasts a domestic and affiliated trade network of such scope as to rival current global reserve currencies such as the British Pound Sterling or even the Euro. At the time of writing, SDRs are drawn out of a combination of the US dollar, the Japanese Yen, the Euro, and the UK’s Pound Sterling.
Each of the international trading hubs attached to these reserve currencies currently faces drastic competition from China’s economic strategy and its undervalued Renminbi. This as a result of its widespread, rapidly developing, international trade network, as suggested by the sheer geography of the country’s Silk Road trade links.
What’s more, the currency is used as the denomination of choice for a growing number of South-to-South bilateral investments, regional infrastructure deals, and preferred currency for the settlement of some capital markets trades. Not to mention the extensive list of foreign acquisitions the country made in the G8 during the 2008 financial crisis, most notably in Italy, Ireland, France, and the United Kingdom.
In order to be admitted into the group of global reserve currencies, the IMF requires: a responsible set of macroeconomic management policies, widespread and international use of the currency in question, a necessarily large domestic and international trade network, and government-backed, free-floating, currency liquidity. How does China stack up in light of these requirements?
Ultimately, Beijing has taken the necessary steps to capitalise itself with liquidity and renewed lending facilities for government institutions in order to sandbag the effect of rapid foreign direct investment outflows and investment panics as investors worldwide realise the seriously speculative prices of equities in the country’s largest exchanges.
From 1994 to 2014, China coped with great difficulty in controlling trillions of dollars of capital inflows and their potentially destructive impact on the country’s economic momentum. In light of this eminent threat, capital controls were, until very recently, rife in China. Today the situation is the complete reverse. In 2014, China experienced net currency outflows of RMB 155 billions, in contrast to a RMB 1.4 trillion inflow only a dozen months before. During the first quarter of 2015, China experienced its biggest capital outflows since the 1990s, hitting a record net outflow of USD 789 millions. Yet the country’s currency and GDP growth rate remained steady its its year on year 0.6% deceleration.
How come? The People’s Bank of China (PBoC) deployed a series of policy tools to bolster its domestic access to credit and liquidity. In January 2013, the country’s central bank created a slew of central banking policy tools designed to provide credit to State-Owned Enterprises and their affiliates, especially in terms of available short term liquidity and credit facilities for lenders under significant liquidity stress sectors. These ranged from immediate short-term liquidity assistance in the form of three-day debt facilities, to three-month long involving convertible debt and bundled collateralized debt obligations.
The PBoC provided upwards of RMB 1.14 trillions in three-months loans to banks under this three-months window, in addition to pledging up to RMB 1 trillion in loan to a chinese SOE with a non-commercial mandate (a State media group). The country’s authorities then moved to audit provincial and municipal balance-sheets to prevent major irregularities from preventing them to successfully list bonds in its burgeoning and increasingly international capital markets. This was meant to prevent China’s SOE-enabled toxic debt at problem from getting worse beyond Beijing.
In addition to these, China has bolstered its capital markets. The Shenzen and Shanghai bourses were allowed to connect with Hong Kong’s more international stock exchange, allowing easier flow of capital to mainland Chinese companies. As a result both mainland indices, grew at spectacular rates over the past few months. Though a financial crisis is currently under way, foreign investors account for about 5% of equities investors domestically. Which points to the fact that the lessons learned from managing the current financial crisis in China will serve to make China’s financial regulators up to the global standard for reserve currency countries.
Negotiations between the US Treasury and China’s economic planners ahead of S&ED Dialogues in 2010 depicted a 3% appreciation target as the basis for an agreement on the Renminbi’s value. China’s Xi Jinping and Hu Jintao put in place structural macroeconomic reforms designed to increase domestic consumption.
One of the key structural factors that underpin a low Renminbi. Depending on how Chinese regulators handle the country’s economic momentum in light of early June’s confidence-busting developments, it is plausible that last week’s Strategic and Economic dialogues have already given way to a deal regarding how liberalised the renminbi must be to gain reserve currency status.
All things considered, China’s entry to the group of global reserve currencies is a matter of time. This should not prove be too lengthy a wait, as the managed appreciation of the Renminbi to levels is expected to put an end to its official denomination as a currency manipulating economy, according to the US Department of Commerce and the World Trade Organization. This change is one of many in today’s global economy, points to the return of a multipolar international monetary setting. One that opens the door for an other BRICS reserve currency down the road.
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Yves Guillaume is an analyst of international finance, strategy, and geopolitics. He is Associate Editor, Trade and Economy, at iAffairs Canada and Global Brief magazine; as well as a Research Fellow at the NATO Council of Canada. He frequently comments on foreign and public policy on CTV National News and the Huffington Post. Prior to being a Chartered Financial Analyst (CFA) Program Candidate, he studied political science at the University of Toronto.
Featured Photo By Matt Paish.