The world seems to have suddenly woken up to the realization that the day may not be too distant when the yuan (or the renminbi as it is officially called) becomes the international currency. Over the past two years, the quiet ascendancy of the yuan was almost drowned in the cacophony of the dollar-yen tussle, but a string of developments have made observers sit up and consider the implications of having the yuan in the No. 1 spot.
For four decades, the dollar has spent an uneasy time on top, realizing fully well that the breakdown of the Bretton Woods system had brought an official end to its rule. In the decades since, scenes from the early decades of the 20th century when the dollar replaced the pound as the numero uno were re-enacted several times over. The yen threatened to replace the dollar in 1980s and the euro in the late 1990s, but the developed nations hadn’t quite anticipated that an emerging economy would present a serious alternative and that, too, in such a short span of time.
One of the reasons why the major powers find themselves in this state is the fact that the Chinese officialdom has adopted an unobtrusive posture on this delicate issue. Unlike in the past when supporters of the yen and the euro had not fallen short of putting forth persuasive arguments in favour of their respective currencies, the Chinese have, by and large, been reluctant to aggressively push their currency on to the centre stage. They maintained this stance even as debates on the future of the dollar became more intense. Thus, on the eve of the London summit of the Group of Twenty (G-20) members in 2009, China’s central bank governor Zhou Xiaochuan tabled a proposal arguing for the overhaul of the global monetary system. He proposed to replace the dollar with the Special Drawing Right (SDR), which is to be a broad-based international currency—usable not only as a reserve asset, but also for trade settlement and accounting around the world. The International Monetary Fund created SDR in 1969 as an international reserve asset to supplement its member countries’ official reserves when supply of two key reserve assets, viz. gold and the dollar, was found to be inadequate for supporting the expansion of global economic transactions. The value of SDR is based on a basket of four key international currencies—the dollar, the euro, the yen and the pound—that is reviewed every five years.
But it was not a mere replacement of the dollar that Zhou was arguing for—he was in favour of strengthening of the SDR through the introduction of a super-sovereign reserve currency that could not only eliminate the inherent risks of credit-based sovereign currency, but could also make it possible to manage global liquidity. The most significant element of Zhou’s proposal was his suggestion to alter the valuation of the SDR. First, he argued that the basket of currencies forming the basis for SDR valuation should be expanded to include currencies of all major economies, and their GDP may also be included as a weight. Further, the allocation of the SDR, in his view, should be “shifted from a purely calculation-based system to a system backed by real assets, such as a reserve pool, to further boost market confidence in its value” (emphasis added). This proposal for reforming the SDR was couched in generalities, but its underlying message was quite unambiguous—the yuan was to be the fulcrum for the change.
Although there has been some support for the SDR reform proposal in the past, in recent months the strongest endorsement it has received till date has been in BRICS (Brazil, Russia, India, China and South Africa) summit held in April 2011. The five major economies outside the developed world endorsed the view about the “role of the SDR in the existing international monetary system, including the composition of SDR’s basket of currencies”. Equally significant was the development in the meeting of the G-20 finance ministers and central bank governors wherein it was decided that the yuan should be included in the SDR.
For a long time, observers of the global financial system were used to dismissing the possible emergence of the yuan as an international currency arguing that the Chinese authorities were determined not to allowing lift their stranglehold over their currency. In so doing, the observers were turning a blind eye to a series of developments involving China and several of its partners wherein the yuan was increasingly being used for settlement of trade.
In April 2009, China launched the pilot project of yuan cross-border trade settlement in five cities, viz. Shanghai, Guangzhou, Shenzhen, Zhuhai and Dongguan, and three months later, extended it to 20 provinces and cities. At the same time, the overseas areas included in the projects were expanded to cover all its trading partners. Although the scheme was slow to take off, by the end of the first quarter of 2011, the yuan-settled trade was 7% of the country’s total foreign trade in the first quarter of 2011. The momentum of the yuan-settled trade is expected increase in the immediate future—a recent survey conducted by HSBC Bank reveals that more than half of China’s total trade will be settled in yuan by 2015.
Biswajit Dhar is director general at Research and Information System for Developing Countries, New Delhi.
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