(This article was originally published by the Official Monetary and Financial Institutions Forum (OMFIF) in the The OMFIF Commentary.)
China appears likely to speed up promotion of the International Monetary Fund’s special drawing right under a plan to prepare a platform this summer for SDR borrowing by Chinese and foreign entities on China’s onshore capital market.
The initiative will help fulfil several strategic Beijing monetary and economic objectives. These include boosting international acceptance of the renminbi, which enters the IMF’s composite currency unit in October with a weighting of around 10.9%, joining the dollar (41.7%), euro (30.9%), yen (8.3%) and sterling (8.1%) as officially recognised reserve currencies.
Beijing’s SDR capital market initiative will allow domestic Chinese investors to subscribe to domestic bond issues with a significant foreign currency component, a means of helping dampen capital outflows that have gained prominence in the last 18 months as a result of progressive capital liberalisation.
The SDR borrowing platform seems likely to be set up as early as July, earlier than expected, in advance of the Chinese currency’s formal SDR adherence. This will necessitate creating a synthetic SDR that can be related, through forward pricing, to the ‘new’ SDR being created in October. This step could lead the IMF to update its procedures for fixing the SDR, which at present is set daily, but in future may need to be established on a 24 hours a day basis.
China is open to extending further the number of currencies in the SDR basket. It would favour, for example, the rupee eventually joining in line with India’s desire to internationalise its currency – but China stresses this should take place only if driven by capital market requirements.
The Chinese SDR initiative, depending on the market response, could allow the SDR to become a currency in its own right, rather than an artificial, narrowly used aggregation of leading currencies. But this is a long journey that faces many hurdles and may never be completed. Foreign sovereign issuance of renminbi bonds is at a very preliminary stage. The UK government raised Rmb3bn in an offshore bond in October 2014. South Korea issued a Rmb3bn domestic Chinese ‘panda’ bond in December 2015, a pioneering action that could pave the way for further such transactions in both SDRs and renminbi.
If Chinese resident investors become keen purchasers of SDR-denominated bonds, as well as domestic renminbi bonds by foreign borrowers, this will contribute to improving the health of China’s international balance sheet.
Chinese officials have long backed shifting China’s net foreign assets (the difference between external claims and liabilities of China’s combined public and private sectors) towards foreign holdings by non-public sector investors. Furthermore, officials would welcome denominating some of these claims in renminbi rather than in foreign currencies led by the dollar.
Bringing the Chinese currency into the SDR, in a long-term move trailed by Chinese officials to produce a new ‘super-sovereign reserve currency’, was agreed last November, after a short, decisive Beijing campaign to win acceptance.
The decision marks the latest stage in a long Chinese effort to lower the dollar’s international monetary dominance. Yet the US Treasury joined the other international representatives on the IMF executive board in unanimously approving the renminbi’s inclusion. The US believes that, by obliging Beijing to open up its capital markets and other parts of the economy as a quid pro quo for the renminbi upgrading, the West has won a worthwhile prize in accelerating China’s international economic integration.
Zhou Xiaochuan, governor of the People’s Bank of China, has been the public face of Beijing’s SDR campaign. He said at the end of March in Paris that China intended issuing domestically orientated SDR-denominated bonds to promote the composite currency’s use.
A nascent market in SDR bonds started in the early 1980s but never took off, because of the wide gulf between the official use of the SDR as a reserve currency unit and the virtually non-existent private market for the SDR in market transactions. As a result of latest Chinese action, the gap could narrow in future years.
