You’re not the yuan that I want

The yuan will now be included among the basket of currencies that make up its so-called Special Drawing Rights

In its ongoing quest for glory and global influence, China appears to have won a notable victory. The International Monetary Fund (IMF) is set to anoint the renminbi—the “people’s currency”, also known by the name of its biggest unit, the yuan—as one of the reserve currencies along with the dollar, pound, euro and yen. For those who fear (or hope) that China will eventually transform the postwar economic order, this appears to be the first step towards dethroning the dollar.

The IMF’s decision, however, is mere political theatre. The yuan will now be included among the basket of currencies that make up its so-called Special Drawing Rights (SDR). As the IMF itself notes, “the SDR is neither a currency, nor a claim on the IMF”. Holders simply have the right to claim the equivalent value in one or more of the SDR’s component currencies. Central banks and investors won’t suddenly be required or even explicitly encouraged to use the yuan.

Indeed, all that’s changed is that it’s now clear that the IMF isn’t blocking the yuan from becoming a true global reserve currency: China is.

To the contrary, the IMF appears to be doing everything it can to help China. SDR currencies are meant to be “freely usable”, which the IMF defines as “widely used to make payments for international transactions” and “widely traded in the principal exchange markets”. The yuan’s champions note that the currency has grown from being used in less than 1% of international payments in September 2013 to 2.5% in October—among the top five globally. This metric, however, enormously overstates the yuan’s influence.

True, China is the world’s second largest economy and its biggest trading nation. Yet, more than 70% of payments made in the yuan still go through Hong Kong, primarily due to its strategic location as a shipping and trading hub for the mainland. All but 2% of yuan-denominated letters of credit are issued to Hong Kong, Macau, Singapore and Taiwan to facilitate trade with China. Even in Asia, the yuan isn’t accepted as collateral for derivatives trading and similar financial transactions. Instead, it’s used almost exclusively for trade in physical goods where China is one of the counterparties.

Nor is the currency widely traded in financial markets. Hong Kong, the largest centre of yuan deposits outside of China, holds less than 900 billion renminbi, or about $140 billion. That’s $40 billion less than Coca-Cola’s market cap (and barely one-fifth the value of Apple’s). The entirety of yuan deposits held outside of China still amounts to less than the market capitalization of the Thai stock market.

This isn’t the result of prejudice against China, but deliberate policy. Take the oft-cited statistic that 2% of global reserves are already held in renminbi. Virtually all yuan reserves are held under swap agreements with the People’s Bank of China, rather than as physical currency. That means China’s central bank maintains control over the currency and its pricing, and can refuse transactions if needed. While other central banks have significant latitude to engage in onshore renminbi purchases, they face restrictions on using the currency outside China.

Bulls say that including the yuan in the SDR will give a boost to reformers, who will open up the Chinese financial system over time. The problem is that there’s little evidence to support such optimism. Over the past two years, renminbi usage in financial markets outside China has been flat. According to Barclays, the amount of offshore yuan-denominated debt has shrunk since the middle of last year, while deposits in Hong Kong haven’t changed much since January 2014.

The irony is that there is, in fact, enormous demand for more yuan among international investors and central banks. Goldman Sachs has estimated that $1 trillion in international reserves would flow into Chinese debt markets if the government truly opened them up.

Yet as economist Barry Eichengreen has noted, when it comes to reserve currencies, investors care most about “size, stability and liquidity”. China’s firm grip on the yuan undercuts all three: It limits the pool of renminbi available and subjects the currency’s movements to the whim of Chinese policymakers.

Investors everywhere are prepared to tolerate some currency and asset price volatility. What they fear are haphazard policy responses, knee-jerk regulation, and opaque institutions—all of which are hallmarks of Chinese financial regulation. As long as central banks and investors have to worry about whether they can buy and sell renminbi as and when they need, the IMF’s stamp of approval isn’t going to make the currency any more attractive. Bloomberg

Christopher Balding is an associate professor of business and economics at the HSBC Business School in Shenzhen.

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