Authors: Matthew Harrison, HKIIF and Geng Xiao, PKU
With the renminbi used for only around 2 per cent of international transactions and reserve holdings, it’s still far from supplanting the US dollar as the currency of choice and its use lags far behind what China’s 16 per cent share of the global economy would suggest. The renminbi isn’t well placed to be a reserve currency. Rather, the International Monetary Fund’s (IMF) special drawing rights (SDR) would be the ideal candidate for global settlements.
It’s well known that China is not by itself in sharing dissatisfaction with the US dollar-dominated international monetary system (IMS). But replacing the dollar with another national currency is not the answer. We have high hopes for the SDR — presently just an IMF reserves-accounting convention. The IMS is in near-crisis and the SDR offers a way out.
The post-Bretton Woods non-system of free-floating currencies has accommodated trade and investment expansion at the cost of recurring instability and financial crisis. The IMS is recession-biased. Trade debtor countries such as Greece are forced to restructure when most painful to do so, while creditor countries such as Germany face no sanction. The IMS is also inequity-biased. Developing countries accumulate precautionary reserves while subsidising the world’s richest economy — the United States — and propagating trade imbalances. Dollar monetary policy is intended to serve US interests, not global needs. The IMF intervenes only once approached and has limited resources and authority. A revamp of the IMS is needed.
Proposals for revamping the IMS outside of renminbi internationalisation include enlarging the role of the IMF, resurrecting Keynes’ bancor or constraining private capital flows. These have obviously gained no traction.
But renminbi internationalisation would be of limited assistance. Even if the US dollar’s share were gradually replaced by the renminbi, little would change. The world would still be dependent on a national currency managed according to national needs, with the same destabilising effects.
The renminbi is not replacing and should not replace the dollar. A global currency must be available to the world through continuing trade deficits. This is not a stable path for the United States or China. A global currency must have a variety of uses, but there is limited use for the renminbi outside China — where it’s still subject to strict capital account controls. Renminbi internationalisation is not consistent with China’s state-permeated system, even in the long run.
Introducing wider systematic use of the SDR would help solve the challenges of the current system. The SDR represents a basket of the world’s leading currencies, with its value based 42 per cent on the dollar, 31 per cent on the euro, 11 per cent renminbi, 8 per cent sterling and 8 per cent yen — a weighted combination of the world’s major currencies. If the SDR could be used for trade settlements, reserve holdings and investments, the stresses and imbalances of the IMS would be reduced automatically.
In 2009 China called for reform of the IMS including broader use of the SDR. The IMF responded, upgrading the renminbi to become an SDR-constituent currency. There were SDR bond issues made in Shanghai, albeit still settled in renminbi. Hopes nevertheless foundered on the liquidity premium — the return investors are willing to forgo in exchange for being able to sell an asset more easily — that was needed to attract SDR buyers. It appeared as if an SDR market couldn’t gain momentum.
But the liquidity premium exists relative to the dollar; not all investors have ready access to dollars. Mainland Chinese investors, constrained by capital controls, might not perceive an SDR liquidity premium. They might even perceive a liquidity discount — an incentive to buy SDRs.
This, then, would be the way forward. China would make the SDR integral to its capital account liberalisation. Via Hong Kong, core infrastructure around SDR pricing, settlement and daily interest rate-setting could be established. China-based issuers seeking foreign currency would get preferential approval for SDR bond issuance.
Chinese investors would be permitted unlimited holdings of SDR deposits. Banks, brokers and service providers would be able to participate in and support China’s SDR market, as would foreign players channelled through Hong Kong. Quotas would control conversion into and out of renminbi. China’s SDR market could open either nationwide or in specific regions such as Shenzhen — a national financial centre slated for bolder reform. An internationally connected SDR ecosystem would then evolve.
For China, an SDR initiative provides a mechanism for financial market opening in a controlled manner. Since the SDR is around 11 per cent renminbi, further renminbi internationalisation would be achieved at a stroke and China would gain kudos as initiator.
For the world, a flourishing SDR market would be a valuable asset. Through the participation of sovereign wealth funds, pension funds and commodity players, the SDR market would extend globally. With the IMF and SDR-constituent sovereigns providing support, progress would speed up. This would contribute to a more stable IMS and perhaps greater understanding between countries.
Matthew Harrison is Senior Researcher at the Hong Kong Institution for International Finance (HKIIF).
Geng Xiao is Professor and Director of the Research Institute of Maritime Silk-Road at the HSBC Business School, Peking University, and President of the Hong Kong Institution for International Finance (HKIIF).