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Focus: Renminbi Swap Network - Systemic importance of SDR entry

by Yaseen Anwar

Systemic importance of SDR entry

The renminbi’s official entry into the International Monetary Fund’s special drawing right bestows on it credibility as a reserve currency, and brings it closer to being freely usable. Systemically, the renminbi can now take its rightful place in the diversified asset allocation strategies of central banks and money managers.

This will mitigate the potential depreciation of local currencies and the value of a country’s reserves when monetary policy developments linked to a dominant reserve currency cause sudden fluctuations. This risk was realised in 2013 when the US Federal Reserve disturbed markets by voting to taper its asset purchasing programme. The ‘taper tantrum’ that followed triggered a significant depreciation in the currencies of Turkey, Brazil and India, among other countries. As the renminbi gains more traction in the international monetary system, any future flight to safety and search for yield may create less volatility and uncertainty.

Countries with low reserves and which have no or limited access to global debt markets owing to poor ratings would be able to ease balance of payments pressures by drawing under the currency swap agreement. In such cases, those countries could maintain stable reserves under the watchful eyes of rating agencies. Thanks to renminbi liquidity through the swap line, Pakistan has been able to meet the conditions of net international reserves targets under the IMF facility.

Greater acceptability for the renminbi
In the light of projected growth rates for China and the rest of Asia, the renminbi is likely to continue to attract greater acceptability and usage over the next 10 years. This should help it become the second official reserve currency behind the dollar, albeit with a large gap. This recognition will be enhanced by the development of Chinese capital markets, as a large working population begins to retire and seeks higher returns than deposits can offer.

Correspondingly, the Chinese authorities will promote the growth of mutual funds, insurance products and fixed income instruments. Such developments will help lift the Chinese economy into the No.1 position globally.

OMFIF Bulletin November 2016 Anwar RMB

Asia’s projected economic dominance in the coming decades is likely to see greater and more active interaction between central banks in the region, along with more transparency and higher corporate governance standards. This is the philosophy of the Chinese leadership, and it will become the hallmark for central banks actively engaged with China’s economy.

However, the SDR is unlikely to become a pivotal unit of account in the near term. Markets must first digest the renminbi’s entry into the international monetary system, and accept China’s position on the global stage as it establishes its leadership role, both economically and politically, beside the US.

Yaseen Anwar is former Governor of the State Bank of Pakistan.

For the pdf of the Focus report please click here