Oil futures test for renminbi
Measuring trust in China system
by Ben Robinson
Wed 2 Dec 2015
In early 2016 China is likely to begin offering oil futures contracts – priced in renminbi and available to foreigners – on the Shanghai International Energy Exchange. The goal is to create a Chinese pricing benchmark for oil to rival those in Europe and America. The results of this effort will be an important further test for the currency’s internationalisation, following its acceptance into the special drawing right, the International Monetary Fund’s basket of reserve currencies, announced on Monday.
By increasing the amount of international payments settled in renminbi, the Shanghai oil contracts will boost the currency’s claim to be ‘widely used’ and ‘freely usable’, two of the technical criteria on which the IMF based its SDR decision.
Extending the Chinese currency’s use in pricing commodities is a significant component of the Beijing authorities’ drive to raise international confidence in the currency and ultimately expand monetary policy autonomy.
To establish an effective Chinese benchmark the Beijing leadership needs to assure foreign traders of the currency’s stability, and to instil confidence in China’s economic strength and in its political and legal systems. Achieving these goals on a sustainable basis will be harder than satisfying the IMF’s SDR criteria.
Full renminbi internationalisation will involve an extension of Chinese legal jurisdiction. China must show it can enforce financial contracts beyond its borders, including in issuing and regulating bonds and other securities. To do this effectively will require acceptance by the international community of China’s increasing monetary and financial clout. As international financial transactions involving renminbi grow in number, however, conflicts will be inevitable.
The US, for example, is unlikely to accept Chinese legal authority over renminbi-denominated oil trades between two companies domiciled in the US. China however will be concerned with enforcing its claims to legal jurisdiction in these cases. Frequent tussles like this would lower confidence in the currency’s usability.
An additional challenge for attracting sufficient interest in the Shanghai oil contract lies in reducing the risk of a repeated sudden drop in the currency’s value of the sort seen in August – something the People’s Bank of China, immediately after the SDR decision, has pledged to avoid. Further, this year’s increase in bond market defaults has emphasised the risks from China’s relatively immature markets.
One of the biggest challenges is that, in pursuing currency internationalisation, Beijing must either give up control over the exchange rate or surrender the central bank’s ability to regulate the domestic economy through independent monetary policy. The interventionist response to the dramatic stock market fall earlier this year, and the protection of state-owned enterprises in the Chinese bond market – where only private companies have been allowed to default so far – underscore the high level of domestic political interference in monetary and financial matters. There are legitimate doubts about whether the government is willing or able to make the concessions needed for full internationalisation.
Thorny legal, financial and political issues will dog the progress of renminbi internationalisation. The development of the renminbi oil futures market will constitute an important test of how well it succeeds.
Ben Robinson is the economist at OMFIF.
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