The yuan and the SDR

AT SOME point, the RMB will be ‘solidly number four’ as the fourth most commonly used currency in global interbank settlements, overtaking Japan, says SWIFT Chief Executive, Gottfried Leibbrandt . . .

From October next year, the Chinese currency, the yuan, will become part of the basket of reserve currencies of the International Monetary Fund’s Special Drawing Rights (SDRs).
It will stand alongside the US dollar, the yen, the Euro and the British pound in the basket of SDRs. The SDR is an international reserve asset created by the IMF in 1969 to supplement its member countries’ official reserves.
The IMF has determined that the Chinese renminbi will take up 10.92 per cent of the SDR basket — a bigger weight than that given to either the Japanese yen or the pound sterling.
The US still holds a 41.73 per cent weighting in the SDR bsket, followed by the euro with 30.93 per cent.
By including the yuan in the SDR basket, the IMF’s Executive Board is saying that, effective October 1 next year, the Chinese renminbi is classified as a “freely usable” currency.
For Beijing, this is certainly a big move forward. And there will be celebrations. October 1 coincidentally, is China’s National Day.
But for many, the question remains: Is the Chinese currency really freely usable?
In one sense it probably is. According to SWIFT, (the Society for Worldwide Interbank Finance Communications), the renminbi became the fourth most commonly used currency in global interbank settlemeunts in October, overtaking Japan.
But SWIFT Chief Executive, Gottfried Leibbrandt, believes the RMB and the yen will go back and forth in fourth and fifth position for some time to come. Then, he adds, at some point, the RMB will be “solidly number four”.
Addressing the annual SWIFT Summit, SIBOS 2015, in Singapore, Leibbrandt  conceded that the RMB has had an impressive rise. “It started in position 17 about two years ago when we began tracking,” he said.
But Leibbrandt, like many others who spoke about the Chinese currency at SIBOS, added:
“I don’t expect the RMB to be the reserve currency or even a reserve currency of the world (soon).
“If we go back to history and remember the US dollar, it only overtook the pound as a global reserve currency in the 1880s. (That is) when US GDP became the largest in the world, but it was 30 or 40 years after World War One, with a significantly weakened British Empire and finances.
“The US had developed deep, liquid and sophisticated domestic capital and financial markets. (So) I think it will be a while before the RMB gets there, and it will be very interesting to watch its rise.
“At the end of the day, the move from the West to the East will continue. It will not happen overnight, but it will continue very steadily, creating opportunities for banks in both the East and the West.”
Currently, some 62 per cent of the world’s foreign exchange reserves are denominated in the US dollar, 25 per cent in the euro, four per cent each in the British pound and the yen, 1-1.5 per cent in Swiss francs,  and about one per cent in RMB, according to leading China economist, Chi Lo. Chi who is senior economist with BNP
Paribas Investment in Hong Kong, says there have been “seismic changes” in global financial markets. There is now a window for the RMB to rise because of structural flaws behind the major currencies – the greenback, the euro and the yen.
He believes the level of trust in the US dollar is eroding, while continuing uncertainty in the Eurozone is not helping the euro. The Japanese economy has its own structural problems.
Against this background, Chi says the RMB has an important role to play in reshaping the world of foreign exchange.
The volume of Chinese yuan used in trade settlements has risen from around RMB10 billion a month in 2010 to RMB 1.3 trillion today. In fact, more than 20 per cent of China’s foreign trade is now settled in RMB.
The Chinese currency has become one of the most widely-used currencies in Asia.
The pool of RMB sitting in Hong Kong has grown from zero to almost RMB1 trillion in seven years. Many countries in Asia now issue bonds in RMB — the Dim Sum bonds in Hong Kong,
Formosa bonds in Taiwan and Lion City bonds in Singapore.
In October, China picked London as its first non-Asian overseas financial centre in which to open a sovereign debt market. Within weeks, the Chinese central bank, the People’s Bank of China, had issued short term, one-year bills which were six times over-subscribed.
Following this success, China is now expected to issue long-term Chinese treasury bonds in RMB in London, which became the first Western country given the status of a RMB clearing bank in 2014.
Fourteen banks around the world have now been designated as RMB clearing banks.
But the market has been jumpy following
China’s recent move to impose capital controls and other measures following the dramatic collapse in August of its share markets.
Speaking at a SIBOS panel discussion on
China on the RMB, Becky Liu, a rates strategist at Standard Chartered in Hong Kong, said issuance in the Hong Kong Dim Sum bond market declined sharply immediately after August.
Liu said gross issuance in September was down by more than 90 per cent from the monthly average earlier in the year. The primary market has since been recovering, supported by the Government and State-owned bank issuances such as the PBoC bill offering in London.
“Despite this, current issuance remains at around 50 per cent below the pre-August average,” she says. Due to the high run-off rate of the Dim Sum bond market, the market could shrink further. She says around 40 per cent of outstanding securities will mature in the next 12 months, and, given a lacklustre primary market, this suggests that the outstanding Dim Sum bond market is likely to shrink further in the quarters ahead.
The question now on many lips is just when the world might see full convertibility of China’s current account.
Expectations are growing, and depending on who one talks to, the time frame can either be rather short or long. If you ask the Chinese, the inevitable answer is always that it is difficult to give a precise time.
The reality is that China is inching ahead at its own pace, constantly juggling with domestic realities and international expectations.  Sources told ATI that China is certainly moving towards opening its capital account, but this has to be managed carefully because of the danger of capital leaving the country en masse.
The sources noted that there were chaotic and massive outflows in the first two quarters of the year, and these prompted drastic reaction from Chinese authorities, who blamed the outflow for China’s declining foreign reserves.
But Chi says this decline is on the back of a rising trade surplus, and that net FDI inflows may not necessarily reflect serious large capital outflows. Rather, he says, a large part of the decline reflects the impact of depreciation on the basket of currencies against the US dollar in which Chinese reserves are held.
China’s reserves consist of foreign assets denominated in seven major currencies,
including the euro, the yen and the pound sterling. The fall of these major currencies against the US dollar since mid-2014 reduced the value of China’s reserves by as much as US$260 billion in the second quarter of 2015, according to Chi.
On the surface, it is estimated by some
observers that China suffered outflows of US$300 billion between the third quarter of 2014 and the second quarter of 2015. After
allowing for the valuation effect, actual capital outflows are likely to be smaller, he says.
Sources told ATI that the internationalisation of the RMB is being delayed for fear that the Chinese people will rush to export their capital. They say that, since 2010, the risk of capital flight has increased. The Chinese are getting around their inconvertible currency by converting it into hard assets overseas. Real estate is the most common asset.
There are many ways for the Chinese to get their money out of China — through over-
invoicing, using credit cards to withdraw cash outside the Mainland and through gambling in casinos in Macau.
It has been reported that one of the tricks used by Mainland Chinese is to use credit cards to withdraw large amount of cash for fake purchases overseas.  “Beijing has plugged the loopholes, but the sky is the limit in Chinese creativity, “says one source.
It is hardly surprising, then, that Beijing has to agonise on the best course of action
forward. It is not as straightforward as many outside China think.
Things are different in China.

n China continuing to free up its financial      markets, page 20