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Analysis
Repercussions of renminbi roller-coaster

Repercussions of renminbi roller-coaster

China currency switch reinforces bid to join SDR 

by David Marsh

Mon 17 Aug 2015

After last week’s changes in Chinese arrangements for handling the renminbi’s exchange rate, the contours of the currency’s expected entry into the special drawing right next year are becoming clearer.

Last week’s roller-coaster renminbi decline against the dollar was widely portrayed as a ‘devaluation’ that could disrupt world capital markets and possibly derail Beijing’s plan to become part of the International Monetary Fund’s composite currency unit.

However it is more probable that the adjustment in the dollar-renminbi link forms a central element in an orchestrated strategy with the IMF that increases the likelihood that the renminbi will indeed join the SDR, in a decision that would be implemented in September 2016.

Another indication of a harmonised plan on SDR adhesion came with Friday’s release of gold data by the People’s Bank of China (PBoC), for the second time in a month, showing the bank bought 19 tonnes of bullion in July to take holdings to 1,677 tonnes. A month ago, China ended six years of silence on its gold hoard, announcing a 57% rise in assets since 2009. Although the figures are not thought to reveal the full picture of Beijing’s official gold holdings, greater transparency on reserves is part of a Chinese bid to conform to international statistical norms and buttress its campaign for reserve currency status.

By becoming the fifth currency in the SDR – after the dollar, euro, sterling and yen – the renminbi would formally join an elite reserve currency club, reinforcing Beijing’s global financial and monetary clout.

Many observers appear to have failed to realise that, if the renminbi is to become a reserve currency, then Beijing will have no choice but progressively to relinquish the peg with the dollar that started already to loosen in 2005. Since then the Chinese currency has appreciated by 30% against the dollar, against last week’s fall of 3%.

Rather than precluding growth as a reserve currency, fluctuations in foreign exchange rate appear to accompany this development. In the initial phases of the D-mark’s participation in what has become a multicurrency reserve system, the dollar roughly doubled in value against the West German currency between 1980 and 1985, and then depreciated by 50% in the next two years, registering similar oscillations against the yen.

In a further sign of a coordinated IMF-Beijing approach, the Fund has released findings of a new survey showing that 38 unnamed central banks and monetary authorities held renminbi assets in 2014, making up 1.1% of global holdings of ‘official assets’ (a wider definition than ‘reserve assets’) , against 27 holders (0.7% of the total) in 2013. 

The figures understate the total number of renminbi holders, since not all the IMF’s 188 members responded to the survey. The IMF data for the first time enshrine the renminbi as the seventh most important world official asset after the dollar (63.7% of the total), euro (21.0%), sterling (4.1%), yen (3.4%), Australian dollar (2.1%) and Canadian dollar (2.0%). The figures show that, of the survey respondents, 127 central banks own dollars, 109 hold sterling, 108 have euros and 88 yen.

Last week’s renminbi softening against a generally strong dollar will help alleviate pressure on Chinese exporters after a 14% real (inflation-adjusted) increase in the renminbi’s trade-weighted value over the past 12 months. Chinese officials have defended last week’s shift in pegging arrangements as a one-off move rather than as a prelude to a full-scale devaluation campaign against the US and other large economies. On the basis that China is trying to become a ‘good citizen’ in the international monetary arena, these protestations appear genuine.

The PBoC on Monday set the renminbi at Rmb6.3969 per dollar, up slightly from Friday’s Rmb6.3975.

A more flexible Chinese exchange rate policy reflects an oft-stated IMF requirement for China to increase the effectiveness of its monetary policies in the face of sizeable and growing capital flows with the rest of the world. The IMF on Friday revealed that its economists in May requested that China move further towards a genuinely floating exchange rate including ‘steps over the next few months … further widening … the band and changes to how the central parity is set’ – foreshadowing the PBoC’s action on 11 August.

China has pledged it will use its $3.65tn foreign exchange reserves to quell any disorderly currency fall but has warned investors to expect ‘two-way volatility’ in renminbi trading. In a statement on Sunday, Ma Jun, PBoC chief economist, said the Chinese government had ‘no intention or need to participate in a “currency war”’ – setting down a marker that should damp expectations of any further strong renminbi decline in coming weeks.

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