Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint

An elusive quest to internationalize renminbi

Special Drawing Rights have lost much of their relevance over the decades

The inclusion of the renminbi in the Special Drawing Rights (SDR) basket of the International Monetary Fund (IMF) is a major boost to Chinese efforts to internationalize its currency. The inclusion is also a reflection of a changing world order. Notably, the renminbi will have a higher weight in the SDR than the pound and the yen. In fact, the euro is the biggest loser, as its weight in the SDR has declined from 37.4% in the 2010 review to 30.93% in 2015.

However, the notion—or the fear—that the inclusion in SDR will automatically propel renminbi to a preferred reserve currency status is exaggerated, because of several reasons. While China is the third largest exporter in the world, its currency contributes just about 1% of the total reserves held globally, according to IMF data. Further, the SDR itself has lost much of its relevance over the decades. It was created in 1969 in a fixed exchange rate era to complement gold and the US dollar as a reserve asset. But the collapse of the fixed exchange rate regime in the early 1970s and the subsequent development of financial markets have given countries the choice to accumulate reserves in different globally traded currencies.

Therefore, more than inclusion in the SDR basket, the future of the renminbi will depend on the opening up of financial markets in China. And there are serious doubts on this account. Although the IMF, in its communication, noted that by 1 October 2016, the renminbi will become a freely usable currency, which is one criterion for inclusion in the SDR basket, there are questions over the extent to which the Chinese government would be willing to cede control and allow market forces to play a greater role.

China is currently in the middle of a structural slowdown, and is trying to engineer a shift from manufacturing-based, export-led growth to a more services-oriented economy. In a state where there are considerable challenges on the economic front, it is unlikely that the Chinese government would want to open up the financial sector in a hurry and induce more uncertainty.

In August, the People’s Bank of China suddenly decided to devalue its currency, which rattled global markets, and when capital started flowing out of the country, partly in anticipation of more such action, the Chinese central bank was out in full force to defend the renminbi. Similarly, when the stock market crashed, the entire government and regulatory firepower was at work to prop up stock prices. Certainly, these are not the traits of a mature market that global money managers are comfortable in.

To be sure, the use of the renminbi has increased in cross-border payments in recent years but that number is still a small fraction of the transactions settled in dollars or euros. The SDR inclusion is likely to motivate some trading partners of China to settle transactions in renminbi and also use it as a reserve asset.

But the internationalization project has a long way to go. For that, China will have to open up its financial market and let go of capital controls, which have been a pillar of the Chinese growth model. Despite the economic strength, the Chinese currency will only gain traction as a reserve or international currency if global money managers and central banks are confident that capital can seamlessly move in and out of the country. It will also require China to build a robust regulatory architecture. Moreover, opening up of the financial market can entail volatility in the interim. There are no clear answers if Chinese authorities are up for such things.

Does this have implications for India? It is true that China is working towards increasing its global influence, both economically and politically, and inclusion of its currency in the SDR basket is a symbolic victory. But India should not get distracted by this development. It should continue with its own efforts to increase the international use of the rupee, and allowing Indian corporations to issues rupee denominated bonds—the so-called ‘masala bonds’—in overseas markets is a step in the right direction.

However, greater internationalization will require fundamental economic support. India at this stage needs deep structural reforms in the real economy to attain higher sustainable growth. Only economic might can ensure India its rightful place on the global economic and political high table.

Will the inclusion in the SDR make renminbi a preferred reserve currency? Tell us at views@livemint.com

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