Renminbi as Reserve Currency: Big Deal or Ho Hum?
Although the inclusion of the renminbi was widely anticipated in the financial community, the reaction to the announcement has been quite varied. The Financial Times, for instance, included a special report in its Monday hardcopy edition, with the lead article under the headline “Pivotal moment for the redback and China.” On the opposite end of the spectrum, the Wall Street Journal quoted one U.S. west coast fund manager as saying, “The actual inclusion of the yuan in the SDR is a nonevent for most investors. The sound you’re hearing is a collective yawn.”
A bite of sniping also took place with former IMF, U.S. Treasury and Federal Reserve officials opining that while the IMF was not willing to break its rules, it was willing to bend them in order to include the renminbi in the SDR. Critics also suggest that the IMF has made a series of concessions to China in recent months that are intended to maintain good relations with the Chinese authorities.
For all the noise surrounding this decision, there are two important takeaways worth mentioning. The first is that from a macroeconomic policy point of view, some flexibility can be gained in the management of the exchange rate. Since the mini devaluation in August, which contributed to a period of market turmoil, the Peoples Bank of China (PBOC) has, from all indications, pivoted to an SDR targeting regime. This broader focus will provide the PBOC more leeway to let markets guide the exchange rate without worrying so much about real effective exchange rate effects on the real economy. In simple terms, policy makers will have more latitude to use measures like changes in interest rates and reserve requirements to maintain the pace of overall economic activity, while transitioning from an investment driven to a consumption driven economy. Ultimately, it will be in the best economic interests of China to move to a fully flexible exchange rate. However, this could take some time, as Chinese leaders remain uncomfortable with financial market volatility.
The second takeaway is that renminbi inclusion in the SDR will help China expand its global economic presence. The country is forging ahead with its commercial efforts to promote the sale of capital goods and high-end industrial products throughout the world. In my opinion, in order to maximize this and other commercial activities, China will need to gradually create a global financial environment that is less dependent on the U.S. dollar as the world’s primary reserve currency. Inclusion in the SDR is an important step in this direction. Also crucial in the realization of this outcome is the need for the renminbi to become cheaper, to make it attractive for borrowing by foreign businesses and sovereign entities.
Although at the moment there might be a collective yawn concerning the announcement about the upcoming inclusion of the renminbi in the SDR, this is not likely to last long, as increasing attention is paid to China as it seeks to use viable tools to maintain its economy’s momentum in its attempt to transition to a more sustainable level of development.