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Analysis
Renminbi SDR boost to global liquidity

Renminbi SDR boost to global liquidity

How Chinese swap network can be turned into dollars

by David Marsh

Tue 18 Oct 2016

This month’s much-heralded entry of the renminbi into the special drawing right could generate a little-noticed boost to global liquidity, adding further to China’s arsenal of international financial instruments outside of established western-guided policies.

The main significance of the Chinese currency’s introduction into the International Monetary Fund’s composite currency unit on 1 October has been to enshrine the renminbi as a reserve currency alongside the dollar, euro, sterling and yen. This is the first time a developing country has joined the elite ‘club’ of countries at the heart of world finance.

Of less obvious importance, bringing the renminbi into the SDR – with a share of around 11%, above 8% each for sterling and the yen – transforms a string of bilateral Chinese swap lines with 31 international central banks into a potential source of dollar liquidity for countries that may run into payments constraints.

Swap accords over the past seven years between the People’s Bank of China and a range of countries from every continent add up to more than Rmb3tn ($500bn). Most of these deals were agreed to help boost bilateral trade invoiced in renminbi, as well as to provide sources of renminbi liquidity for local trading. But only a small fraction has actually been drawn. Moreover, it is likely that China will be quite restrictive in future in allowing partners to access the currency, now that it has a fuller international status.

With the renminbi in the SDR, these arrangements take on more systemic significance, forming a kind of ‘renminbi safety net’ outside the formal network of the US-dominated Bretton Woods institutions.

Under existing SDR buying and selling arrangements with the IMF and a range of countries, central banks that draw renminbi under swap agreements can potentially convert them into SDRs and then into dollars through a series of official transactions.

This means that countries with PBoC swap agreements now have additional possible access to dollars. This could allow them theoretically to leapfrog the existing Federal Reserve swap network – which the US authorities have taken care to maintain on a highly restrictive basis – as well as the IMF as alternative sources of institutionalised international finance.

Among those concluding swap deals with China are the European Central Bank as well as central banks from Australia, Canada, Hong Kong, Qatar, Singapore, Switzerland, the United Arab Emirates and the UK – all of which are highly unlikely to use such arrangements as a route to an alternative source of dollar liquidity.

But China’s swap counterparties also include a variety of other countries including Albania, Argentina, Belarus, Mongolia, Pakistan, Sri Lanka, Thailand, Turkey and Uzbekistan, which would be more likely contenders to make use of such a mechanism.

There is no suggestion that the US regards the possible liquidity significance of the new arrangements with any qualms. In recent weeks the US administration has taken a step towards dropping China from the Treasury’s annual currency manipulation watchlist. This is partly because the renminbi appreciated considerably in the prelude to the IMF’s decision on SDR inclusion in November last year – although since then it has been on a downward trend against the dollar. Additionally, Washington’s relative satisfaction with Beijing represents China’s success in lowering its current account surplus, previously seen as having a destabilising effect on the world economy.

Among the conditions for Beijing’s much-prized designation as running a ‘freely usable currency’, China has liberalised parts of its domestic financial market and provided the international community with hitherto secret financial information, for example that concerning reserve holdings. This despite the risk that such steps towards relative openness could lead to possible economic setbacks for the Chinese leadership.

The SDR move forms part of a gradual amassing of Chinese monetary influence that one day could represent a serious challenge to the international supremacy of the dollar and of American financial markets. China has promoted new international financial organisations such as the Asian Infrastructure Investment Bank, and espoused reserve-sharing arrangements with other major emerging market economies that add up to a shot across the bows of the western-dominated financial establishments. A renminbi-dollar liquidity network spanning the world could, in time, prove another important element of this intensified flexing of China’s monetary muscles.

David Marsh is Managing Director of OMFIF.

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