Investment strategy  

09/12/2015

WHAT THE ‘RENMINBI MILESTONE’ MEANS FOR INVESTORS

The IMF’s decision is a milestone in China’s global economic standing, but the decision  is unlikely to have a meaningful impact on the direction of the currency in the near term.  The renminbi’s value will be primarily driven by China’s economic conditions and medium-term growth dynamics. 

What will happen to the renminbi now that the International Monetary Fund (IMF) has announced its formal inclusion in the Special Drawing Rights (SDR) basket*? The decision, announced on 30 November 2015, means that the RMB is among the supplementary reserve currencies used by the organisation. The move is likely to enhance investor confidence in the currency.

As illustrated in Chart 1, from 1 October 2016, the currency will represent 10.9% of the basket, which currently includes the US dollar, the Japanese yen, sterling and the euro. Although this is another milestone in the long-term transformation of the RMB into an international currency, the decision does not lead us to change our view of continued RMB stability over next 3-6 months.

First, the SDR decision by itself will not force foreign-exchange (FX) reserve managers, outside of China, to significantly change their currency allocations. The SDR is effectively an artificial currency primarily used by the IMF for internal accounting purposes. This means that, in normal times, a large-scale transaction of the SDR in exchange for a particular constituent currency is unlikely to take place. Moreover, such transactions have little relevance to portfolio considerations of most FX reserve managers as they tend not to be passive followers of any benchmark. This is illustrated by the fact that the lack of SDR distinction has not precluded the widespread use of the Australian or Canadian dollars as reserve assets.

Second, any capital flows arising from SDR transactions or FX allocation changes will be small in comparison to China’s usual balance of payment flows. The IMF caps the total scale of its allocation to the SDR1  and adjusts this infrequently. As a result, the maximum allowable for SDR-related transactions for the RMB stands at only US$30 billion. The represents just 0.26% of the US$11.6 trillion FX reserves in the world2  and 10.8% of China’s annual current account balance3.

Third, China continues to favour a gradual approach to easing restrictions on capital flows, and the SDR inclusion does not alter this fundamental bias. While China has implemented various measures to liberalise its economy over recent months, in preparation for SDR decision, the country’s basic FX policy framework remains heavily managed and highly restricted.

In summary, while the SDR decision is a milestone in China’s global economic standing, it will not have a meaningful impact on the direction of the RMB in the near term.  The currency’s value will be primarily driven by China’s economic conditions and medium-term growth dynamics. Looking ahead, we do not envisage a major disruption on either of these two fronts in 2016. As a result of these factors – and notwithstanding transitory volatility resulting from the start of the US interest-rate hiking cycle – we believe the RMB will remain stable in coming months.

*Special drawing rights (XDR or SDR) are supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund . Their value is based on a basket of key international currencies reviewed by IMF every five years

1 Currently at SDR 204 billion, equivalent to roughly US$280 billion, according to the market exchange rate.
2 Estimated data for 2014.
3 A country’s current account balance measures the inflow and outflow of goods, services and investment income across the economy.
 

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