The symbolism over this period reflects the yuan’s (also known as the RMB) rising influence in global politics as well as the continued ambition to become an alternative international currency, all achieved within a relatively short period of time.
Until freely convertible, the RMB will unlikely become the reserve currency. But as negative interest rates and sluggish growth in developed markets plague mature economies, the attractiveness for an alternative should augment. The yuan’s addition to the SDR is the first change to the basket since 1999 when the euro replaced the deutsche mark and the French franc. The new allocation will remain weighted towards the USD and Euro at 41.7% and 30.9% respectively, followed by the RMB at 10.9%. The Japanese yen and the British sterling will take up 8.3% and 8.1% respectively. Overall, SDR makes up a small proportion of global settlement. Around 204.1bn SDR have been allocated to IMF members, which are equivalent to around $285bn, while global reserves account for about $11trn. Thus the RMB’s inclusion will be more symbolic.
In our view, the RMB inclusion into the IMF’s SDR should be mutually beneficial, which is important during a proliferation of rising anti-globalization rhetoric. For China, the SDR promotes the yuan without freely opening the capital account while maintaining a managed float. Central banks with SDR assets immediately become RMB holders, while the yuan would also appreciate relative to other non-dollar pegged currencies. For the IMF, the decision allows them to win back favor as many had criticized the organization for not taking preliminary steps to recognize the growing emerging markets influence, which eventually lead to the China-backed Asia Infrastructure Investment Bank.
For Asian companies, the inclusion provides a conduit for greater RMB use in economic activity, boosting regional trade as global demand ebbs. According to data from Morgan Stanley Research, 51% of Asia Ex-Japan (AXJ) exports are traded to other AXJ countries, rising from 46% in 2006. Over the past decade, evidence of decoupling between Asia and the West has taken place. AXJ exports to the US and EU, which made up 17% and 15% respectively in 2006, has fallen to 14% and 12%.
For the region, China stands as the main trading partner, and integrating domestic capital markets and regional demand portends well for the RMB and Asian economies. This event adds tailwinds to the Shenzhen-Hong Kong stock connect approval, which followed the Shanghai-Hong Kong scheme.
Though unlikely in itself to derail the US dollar as a global currency, the RMB’s inclusion represents an ongoing progress towards China’s goal to further internationalize the yuan. The RMB has depreciated about 5% since its surprised devaluation in August 2015, foreign reserves have stabilized around $3.2trn. The biggest risk in our view is whether the People’s Bank of China (PBOC) allows the RMB to weaken significantly further. Central authorities dismiss this claim, and we concur that a sharp devaluation would significantly hinder efforts to rebalance towards a domestic consuming economy.
Looking forward, new measures aimed at enhancing productivity will bode better. This is particularly true as these reforms lift China’s economy away from the middle income trap and towards one where greater value added services become accretive. Reform is viewed as a multi-year catalyst for Asian equity markets, as Beijing must prepare to open further. The RMB inclusion is an important step, but by no means a concluding one. As China’s macro environment continues to mirror market forces, the PBOC is expected to face greater criticism over the RMB, which ironically would be welcomed, as this is a prelude to become a true international currency.
Data Source: IMF, Bloomberg, Morgan Stanley Research