JUNE 16, 2015
If the IMF wants to keep Beijing in the tent, it's time to reward China's progress on making its currency more free market-friendly.
Will the renminbi (RMB) join the elite basket of currencies that determines the value of the International Monetary Fund’s Special Drawing Rights (SDR)? The decision whether or not to include China’s currency rests mainly with the members of the G-7 economies that have a strong hold on the IMF. If they know what’s good for them, they’ll say yes.
This is a technical decision with deep political implications. It will pave the way for the RMB to be a key international reserve currency, alongside the dollar, the euro, the pound, and the yen. As IMF chief Christine Lagarde said in March, this a not a matter of if but when: this year — or in 2020, when the IMF will again review the composition of the SDR’s basket.
At this point, there’s no reason to wait. Including the RMB this year or, at the latest, in 2016 would send the positive message that China is a welcomed and trustworthy member of the international monetary and financial community — a message that would benefit everyone.
When G-7 finance ministers met earlier this month in Dresden, they indicated that a technical assessment of the RMB was paramount for the final decision, regardless of how desirable the inclusion of the RMB in the SDR basket might be for political reasons. But if the assessment is mainly based on technical criteria such as “free usability” — IMF jargon for a currency that can be used and exchanged everywhere in the world — the RMB may well be excluded. Unlike the dollar, the Chinese currency is not yet fully convertible — you can’t simply exchange as much as you want for other currencies in China’s banking system — and thus not the easiest to use in international markets.
A more fruitful approach might be to assess “its potential for a broader role in the international monetary system,” to quote the IMF, and consider future developments as well as recent achievements. Since 2010, when the IMF undertook its last SDR review, China has promoted the internationalization of its currency through several policy measures, such as the establishment of RMB-clearing banks in Hong Kong, London, and Singapore.
As a result, more than 20 percent of China’s trade is now settled in RMB, up from zero five years ago. Furthermore, the RMB is now the world’s fifth-most used currency in international payments after the dollar, the euro, the yen, and the British pound. The number of central banks and official institutions that hold RMB in their reserves has also expanded, and investment banks estimate that 0.5 to 1 percent of official global reserves are now held in RMB. The issuance of non-Chinese RMB-denominated bonds has also increased to an estimated $120 billion between 2010 and 2014, even if it remains behind in the offshore issuance of the other key currencies.
More measures to promote the international use of the RMB are in the pipeline, as the governor of the People’s Bank of China, Zhou Xiaochuan,announced in April during a visit to Washington. And while greater exchange rate flexibility has already been achieved, more will come as Chinese authorities rebalance the economy to focus on domestic demand. As a result, the exchange rate will gradually move from a managed system to a market-determined one.
In May, the IMF announced that the RMB was no longer undervalued, confirming that China’s monetary authorities are intervening less to control the exchange rate. By contrast, at the time of the 2010 review the Chinese currency was deemed to be undervalued, and the U.S. Congress was particularly concerned about China’s currency manipulation.
If these IMF considers these broader indicators of progress, then the case for the RMB’s exclusion from the SDR basket is not so clear-cut. The only controversial area remaining is capital account convertibility. Here, Chinese authorities maintain that capital flows should be facilitated but also closely monitored, in order to curb undesired and excessive activity. This is capital account liberalization Chinese-style or, as Zhou termed it, “managed convertibility.” This may be a stumbling block if the IMF’s Executive Board decides that “managed convertibility” is still a way to constrain the “full usability” of the currency.
Still, even if the issue of convertibility appears poised to hold the RMB back, the final decision may well rest on politics. Beijing expects that this recognition of the RMB — and its inclusion in the SDR basket — will provide a seal of approval for the Chinese currency. What is at stake here is power and influence in international finance. This seal of approval for the RMB will be an important step in China’s economic and political trajectory, and a recognition of Beijing’s commitment to being an active member of the multilateral monetary and financial system. If, to quote Nobel laureate Robert Mundell, “great nations have great currencies,” then China’s rise remains incomplete without an international currency.
Fortunately for China and its backers, exceptions have been made in the past. For instance, at the time of its inclusion in the SDR basket in 1981, the Japanese yen was a “fully usable” but not a fully convertible currency. To do the same for the RMB would be good politics and smart economics. The best way to test China’s commitment to opening its financial sector, implementing financial reforms, and having a market-determined exchange rate is by supporting the Chinese effort to turn the RMB into a “grown-up” currency.
The issue, therefore, is not to obsessively demand evidence that China fully appreciates the obligations that come with the status of reserve currency. It is rather a matter of whether the rest of the world is prepared to give credit for — and encourage the continuation of — China’s efforts to be a good global citizen.
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