Asset class diversification continues to be a key theme for central bank foreign exchange reserves managers. A survey at a recent gathering of regional central bankers in Asia showed that more than half had amended their strategic asset allocation in the last two years, and more than two-thirds had expanded the permitted number of investible asset classes. Many had either invested in, or had considered, ‘non-traditional’ asset classes, including equities. Almost all expected the Chinese renminbi to become more important as a reserve currency over the next five years.
It is noteworthy that despite a weaker renminbi/dollar rate this year, the Chinese currency has increased its share in global reserves, according to International Monetary Fund data. The latest report, released at the end of September, shows a jump in renminbi holdings of around $50bn in the second quarter of 2018. Less than a decade after the launch of the renminbi internationalisation initiative, we estimate that more than 60 central banks have renminbi in their reserves. But allocations are still relatively small.
The IMF data suggest the global share of renminbi is around 2%, but we should highlight the technical point that nations don’t hold their own currency in foreign reserves. As the world’s largest holder of foreign reserves, China effectively lowers the global reading for renminbi in global reserves. Feedback from central bankers in Asia supports the view that over the next 5 years a move to a 5% global share was probable. This would take the renminbi past the yen and sterling into third place in the reserve currency league table.
There are three reasons why we at Barings believe allocations to the renminbi will continue to increase. First, most nations have explained their decision to add renminbi to their reserves as a need to reflect growing trade flows with China. However, these initial allocations to the RMB have not reflected the existence, but not the magnitude of trading relationships with China. A recent IMF paper suggests the international monetary system is now tripolar, and although still dominated by the dollar, the renminbi trading bloc has already surpassed that of the euro in terms of importance. The renminbi bloc is centred on Asia, and Asian nations (even when excluding the Chinese total) are amongst the largest holders of foreign reserves in the world. These countries will be the key drivers if reserve currency weights are to change.
Second, in response to rhetoric about the US-China trade war and a rise in geopolitical tensions, Beijing may seek to deepen both trade and political relationships with Asian neighbours. Japanese Prime Minister Shinzo Abe made his first trip to China in late October, and used the occasion to announce that the People’s Bank of China and Bank of Japan had signed a $30bn currency swap agreement. This is five years after the previous agreement had expired during a period of frosty relations. One consequence of current US trade and foreign policy action has been to help thaw relations between these East Asian neighbours. It may also help China extend its economic and political influence throughout Asia, encouraging the deepening of financial ties, including the building of renminbi-denominated foreign reserves.
Finally, the onshore Chinese bond market is the third largest in the world, according to Bloomberg data. As index providers continue to include Chinese markets, there will probably be rising pressure for global bond investors, including foreign reserves managers, to increase their allocations to the renminbi-denominated bond markets. Given these factors, the renminbi is likely to continue climbing the reserve currency league table and eventually contend with the dollar for the top spot.
Gary Smith is a Member of the OMFIF Advisory Council and Member of the Macroeconomic and Geopolitical Research team at Barings.