The Renminbi and the SDR — The First Year

来源: CHINA FOREX 2017 Issue 4 作者:Wang Guogang
Two years ago, the International Monetary Fund (IMF) agreed to include the renminbi in its Special Drawing Rights (SDR) currency basket. This important decision, reached with the backing of 188 other members of the fund, went into effect on October 1, 2016. It now has been more than a year since the Chinese currency was formally added to the basket of reserve currencies, and over that period, despite the turbulence of international markets, the renminbi has withstood the test. This has effectively promoted the internationalization of the renminbi, accelerated China's opening to the rest of the world and given a major boost to China's international reputation.

At the same time, it has supported domestic financial and supply-side structural reforms, while paving the way for the nation's “Belt and Road" initiative, an ambitious program that seeks to boost infrastructure development and trade between Asia and Europe. This program could also result in a big role for the Chinese currency in financing and trade. It should be kept in mind that including the renminbi in the basket of reserve currencies requires continuing efforts. According to the provisions of the IMF, the SDR currency basket must undergo a fresh round of assessments every five years, and currencies that fail to meet the IMF requirements can be removed from the basket. Therefore, further efforts will be required to ensure that the renminbi remains an SDR component. This will depend on changes in the international situation and the prosperity and development of China’s economy, including the progress in deepening the nation's reforms and opening the economy.

The First Year's Achievements
A sovereign currency is an indispensable part of any country’s economic and social system. Including the renminbi in this international basket of reserve currencies signals the recognition of China's sovereign currency by the international community. It has enhanced China's standing in the world, amplified the authority of its voice and expanded the influence of its actions.

First, the renminbi has taken an increasingly important role in the international monetary system. In 2016, cross-border renminbi receipts and payments amounted to 9.85 trillion yuan, accounting for 25.2% of China's domestic and foreign currency cross-border payments in that period. The renminbi has been China's second largest cross-border payment currency for six consecutive years. Current account renminbi receipts reached 2.15 trillion yuan and renminbi payments were 3.08 trillion yuan, which means a net expenditure of 927.37 billion yuan. From January to September of 2017, China’s total imports and exports reached 20.29 trillion yuan with a year-on-year increase of 16.6 %. The total of renminbi payments continued to expand.

On the capital account in 2016, renminbi receipts reached 1.63 trillion yuan and payments were 2.98 trillion yuan, which means a net expenditure of 1.35 trillion yuan. On October 6, 2017, the Society for Worldwide Interbank Financial Telecommunication (Swift) published data showing that the renminbi reached a record 2.79% of global payments in terms of value, surpassing the yen for the first time and becoming the fourth largest payment currency in the world. In terms of reserve currencies, the IMF’s Official Foreign Exchange Reserve Currency Composition data show that more than 60 countries and regions have included the renminbi in their foreign currency reserves. At the end of December 2016, renminbi reserves reached the equivalent of US$84.51 billion, accounting for 1.07% of total foreign exchange reserves. By the second quarter of 2017, the renminbi reserves reached the equivalent of US$ 99.36 billion, up 9.5% from the end of 2016. In addition, by the end of 2016, the People’s Bank of China had signed a bilateral currency swap agreement with the central bank or monetary authorities of 36 countries and regions. The total amount of the agreements reached at more than 3.3 trillion yuan. Speaking on October 1, 2017, IMF Managing Director Christine Lagarde stressed that the status of the Chinese currency will be acknowledged by the international community and it will become a freely traded international currency.

Moreover, the renminbi exchange rate remained basically stable over the period after it joined the basket of reserve currencies. Since 2015, with the US Federal Reserve signaling that it would withdraw its quantitative easing policy and gradually increase the federal funds rate, the renminbi exchange rate against the US dollar has shown a downward trend. However, compared with the euro, British pound or the yen, the renminbi exchange rate against the US currency has declined by the smallest amount, indicating that the renminbi is the optimal choice of international currencies. Since 2016, the renminbi exchange rate against the US dollar has continued to rise along with China's strong economic growth and with the efforts of the People’s Bank of China to stabilize the exchange rate. According to data of, since January 3, 2017, the central parity rate of the renminbi against the US dollar has risen by about 5.05%. In this process, the People’s Bank of China actively promoted the reform of the renminbi's exchange rate mechanism. Following the launch of the reform of the renminbi's central parity mechanism on August 11, 2015, authorities added the use of a counter cyclical factor in setting the parity rate as of May 26, 2017. This further stabilized market expectations.

Foreign exchange reserves are the monetary basis of the internationalization of the renminbi. As of the end of 2014, China’s foreign exchange reserves amounted to US$3,843.018 billion, but they declined to US$3,330.362 billion at the end of 2015. To some extent that accelerated the weakening of the yuan against the US dollar in 2015. Since 2016, the State Administration of Foreign Exchange has adopted a series of measures to tighten foreign exchange management, thereby halting the sharp decline of foreign exchange reserves. As of September 2017, foreign exchange reserve assets had risen from US$3,010.517 billion at the end of 2016 to US$3,108.51 billion, boosting the confidence of overseas investors and other nonresidents in holding renminbi. That in turn helped improve the exchange rate of the Chinese currency against the dollar.

Meanwhile, China’s capital market has been undergoing a process of internationalization. According to the People’s Bank of China’s 2017 China International Renminbi Report, 407 foreign institutions had been authorized to take part in the domestic inter-bank bond market and had a bond custody balance of 800.03 billion yuan as of the end of 2016. According to the narrower statistics of the Bank for International Settlements, the balance of international debt denominated in renminbi amounted to 698.72 billion yuan. The balance of outstanding renminbi bonds issued by overseas institutions in the offshore market reached 566.58 billion yuan and the balance of renminbi bonds issued in mainland China was 132.14 billion yuan.

The balance of financial assets held by non-residents in China reached 3.03 trillion yuan. That figure included a balance of 616.44 billion yuan in stocks and 852.62 billion yuan of bonds held in custody by overseas institutions. The balance of loans of domestic institutions borrowed from foreign institutions reached 616.44 billion yuan, and the balance of non-resident deposits at domestic banks reached 915.47 billion yuan. Additionally, the Shenzhen-Hong Kong Stock Connect, a program that links trading on the stock exchanges of the two cities, was officially launched on June 5, 2016. On June 21, 2017, Morgan Stanley Capital International (MSCI) announced that China’s A Shares were officially included in the MSCI Emerging Markets Index and the global index. On July 3, 2017, Hong Kong and mainland China officially launched their bond market cooperation program. This series of initiatives deepened the opening up of China's capital market, providing a new trading platform for global investors to enter the Chinese market. According to the custody data of the China Central Depository & Clearing Co., Ltd. and the Shanghai Clearing House, in August 2017, foreign institutions increased their holdings of bonds by 82.567 billion yuan, a record high.

Additionally, the construction of infrastructure for the cross-border use of renminbi has been accelerated. In 2016, the People’s Bank of China intensified the effort to promote cross-border renminbi payments. At the end of 2016, the number of direct participants in the system reached 28 institutions with 512 participants, covering 80 countries around the world. The cumulative processing and payment business reached 722,849 cases with a value of 4,842.7 billion yuan. On the other hand, the People’s Bank of China has accelerated the construction of the liquidation mechanism of overseas renminbi business, and established renminbi clearing arrangements with the central banks of 23 countries and regions. These included the US Federal Reserve and the Russian central bank and were designed to ensure that enterprises and financial institutions in these countries and regions could deal with cross-border renminbi transactions, effectively promoting trade and investment.

In short, during the first year of the renminbi's inclusion in the basket of reserve currencies, there has been a positive performance of China’s trade and investment, further reform of the international monetary system and the promotion of the more effective international economic development.

Challenges Ahead
It is often said that it is achievements are harder to naintain than to make. Despite the fact that the renminbi's performance as a reserve currency has been exemplary, there is a need for more effort. This depends on the recovery and development of the international economy as well as China’s domestic economic and social development. The series of challenges facing the renminbi in the basket of reserve currencies are as follows.
The turbulent external environment makes the renminbi's role in the basket complex. First of all, the newly elected president of the US, Donald Trump, introduced a series of disruptive policies, which unsettled the international community. Under President Trump's America First policy, the US has withdrawn from the Paris Accord on global climate change and abandoned the Trans-Pacific Partnership agreement that had been ready to link 12 economies. But the US turned away from its open market policies and instead embraced protectionism, using the pretext of addressing unfair imports. It launched a series of initiatives to renegotiate trade and investment agreements with many of its trading partners, such as Mexico and Canada. This suggests that the international trade environment will experience more uncertainty over the next few years.

Meanwhile, Brexit procedures have reached a crucial phase. So far the negotiations between the European Union and the United Kingdom on Brexit terms are deadlocked. Brexit will have a serious impact on the economy and finances of the EU and the eurozone, and this adds even more uncertainty to the global economy. Moreover, the US, Europe and other key economies still refuse to recognize China’s market economy status. Trade friction and protectionism continue unabated. Meanwhile, there are continuing efforts to curb China’s trade growth, and this has brought new uncertainties to China’s foreign trade picture. Finally, Scotland's continuing flirtation with independence from Britain and the Catalonia referendum on independence from Spain are symptoms of political tensions that threaten to unravel existing national and international arrangements. The regions of Lombardy and Veneto, which include Milan and Venice, have voted for more autonomy, and this too could create even more uncertainty in the European Union.

On the monetary policy front, there are fresh areas of uncertainty as well. In June, the Federal Reserve made its second rate hike of 2017, announcing another 25-basis-point rise in the federal funds rate to 1.25%. At the same time, the Federal Reserve also moved closer to actually shrinking its balance sheet, while the Trump administration has considered incentives to encourage American corporations to repatriate funds parked outside the country. This tax treatment is by no means assured but if this is coupled with higher interest rates, the dollar should appreciate. That would put downward pressure on other global currencies, and could also lead to fluctuations in commodity prices in the international market. That in turn could bring further uncertainties to the global economy.

Moreover, the Chinese economy is in a crucial phase of supply-side structural reform. Deleveraging, or the reduction of high debt-to-asset ratios of domestic enterprises (especially state-owned companies), could seriously delay progress in reducing excess production capacity and paring high levels of inventories. There is a need for more corporate mergers and acquisitions as well as asset reorganizations to strengthen some of the weaker corporate entities and avert systemic financial risk. Deleveraging will deprive many companies of needed funds, and this could affect output, employment and economic growth. Therefore, this needs to be done in a gradual way. From the cost perspective, tax cuts and interest rate reductions will help companies.

Meanwhile, the producer price index, after a prolonged period of negative growth, has picked up since September 2016, allowing greater profitability for many upstream producers. These favorable conditions provide a healthier environment for cost reduction. However, to further reduce financing and operating costs, more structural supply-side reforms are needed. From industries hit by overcapacity, innovation, entrepreneurship and the development of emerging technologies could lead to expansion. Accelerated infrastructure construction could help create the needed external conditions for the development of these struggling industries. 

In addition, the prevention of systemic financial risk has been given a more prominent position on the policy agenda. Since 2016, the State Council and financial regulatory authorities have issued a number of key documents aimed at increasing risk control. These include the Notice on Implementation of Special Rectification on Internet Financial Risk, Opinions on Actively and Steadily Reducing the Leverage Rate for Enterprises, Special Rectification on Inappropriate Innovation, Inappropriate Transactions, Inappropriate Incentives and Inappropriate Charges  and  Guidance on Prevention and Control of Banking Risks. These problems accumulate over time and it takes more time to solve them. It will also take time to effectively repair the balance sheets of enterprises and financial institutions and establish effective measures against financial contagion. Moreover, efforts must be made to include coverage of quasi-financial institutions and non-financial institutions in the financial regulatory scope, in order to achieve full financial supervision.

At the same time, there are still uncertainties in the international economic and financial realm and there is a possibility of a sudden emergence of risks. Fluctuations in commodity prices, unpredictable oil prices, possible financial turmoil stemming from the shrinking of the Federal Reserve's balance sheet, trade wars and the Kobe Steel production scandal in Japan could have an impact on China. This could increase the difficulty of controlling systemic financial risks in China. In addition, with the improvement of the international status and the enhancement of international functions of the renminbi, the international influence of the dollar, the pound and the yen will be affected accordingly. Thus, the fight for a greater voice in the international arena, the right to trade (including pricing power) and the currency war for reserves will start in various forms. This will increase international financial risks facing China and bring new challenges to the stability of the renminbi in the reserve basket.

The author is from China Finance and Financial Policy Research Center of School of Finance at Renmin University of China.