Protests over democracy in Hong Kong may be preoccupying the Chinese leadership, but a subject of still greater international importance is being played out this week behind closed doors in Washington. China is bidding to enter the heart of global finance by establishing its currency, the renminbi, as part of an ubiquitous monetary unit used in official transactions around the world.
[by David Marsh | October 7, 2014 | USA Today]
The issue of whether the Chinese should be part of the International Monetary Fund's Special Drawing Right, the composite reserve currency used in official financing, is highly technocratic, but the political questions at stake go to the core of world money and power – and will be discussed, in the background, at the annual meetings of the IMF and World Bank in Washington this week.
The decision on a new SDR structure, to be made in the next 15 months, will influence how China and its currency can play a bigger part in driving world trade, investment and capital flows. The renminbi could eventually challenge the dollar and its pivotal position in world money — which is why the U.S. government and Federal Reserve are examining this with intense interest.
China is unlikely to mount an open campaign to enter the SDR, grouping the main reserve currencies, the dollar, the euro (linking countries in European monetary union led by Germany and France), the Japanese yen and British pound, and is valued at around $1.5.
Beijing would prefer the question of recalculating the composition of the SDR, which comes up for review in 2015, to follow market developments, reflecting a big increase in demand for renminbi financing from private banks, central banks, traders, corporations and asset managers.
Many hurdles remain. These include the renminbi's lack of formal convertibility for transactions that shift capital inside and outside the country, where Beijing is reluctant to abolish all controls. In addition, China still has to release more statistics to the Fund about its monetary reserves and other matters. However, Chinese measures over the past three years to liberalize and internationalize its currency, and a big increase in financial market interest in China, are pointing toward a broadening of the SDR's composition from January 2016.
An additional factor is China's own action to galvanize emerging market economies toward reforming word monetary arrangements. This includes the five-nation Brics group's decision to set up the New Development Bank in Shanghai, potentially challenging the IMF and the World Bank.
As the world's No. 2 economy after the U.S., China believes it is close to earning the status of a reserve money, the first time that an emerging market currency would attain this position. Chinese entry into the "magic circle" has been advanced by the British government's September decision to issue renminbi-denominated bonds, the first big government to take such a step, and allow the proceeds to be held as reserves by the Bank of England.
The main conditions for the renminbi to pass the SDR test are that it should be widely used in trade and be "freely usable" in international payments and asset management. Although a long way behind the dollar, the renminbi has made impressive strides recently and is challenging the euro in several key fields.
Next year's planned review will touch, too, on the opportunity for the SDR to play a greater role on financial markets, for example in denominating bond issues. The SDR has lost ground as a financial vehicle in the past two decades, reflecting the surging importance of international private sector capital markets. But with the addition of the renminbi, it may be about to make a comeback.
David Marsh is Managing Director of Official Monetary and Financial Institutions Forum, a London think-tank.