Insight archive for Jukka Pihlman | Standard Chartered

Renminbi – opening the gates

Jukka Pihlman — Mon, 30 Nov 2015 19:08:55 +0000

Following the earlier announcement in November that the renminbi (RMB) meets the International Monetary Fund’s (IMF’s) criteria as a ‘freely usable’ currency, the IMF Executive Board has now formally decided to include the RMB in its Special Drawing Rights (SDR) basket of currencies from 1 October next year.

This came as no surprise to those who have followed China’s unprecedented steps to open up its capital markets.

A monumental milestone for the RMB – which enters the SDR with a weighting of almost 11 per cent – this event will trigger significant but gradual inflows of funds into RMB, changing the global currency landscape forever, as central banks, sovereign wealth funds (SWFs) and multilateral institutions recalibrate their balance sheets.

"As many as 70 central banks have already invested part of their reserves in renminbi"

Many will not wait until next year before taking action. Indeed, as many as 70 central banks have already invested part of their reserves in renminbi, either onshore or offshore.

The reforms made by China to qualify for SDR inclusion have been so radical that – to public sector investors – the RMB has become fully convertible with no restrictions on access or size of investment in the China interbank bond market, something which has largely gone unnoticed.

Five out of the world’s 10 largest central banks have so far refrained from investing in the Chinese interbank bond market. However, because of China’s recent reforms, these and many other public sector investors are now reviewing their stance.

Double-digit share of global reserves

Eventually, we should expect to see RMB reach a double-digit share of global reserves – inflows in the order of USD800 billion to more than USD1 trillion. Even a conservative estimate of reallocation of about 1 per cent of global reserves each year would mean about USD80 billion inflows annually – no mean sum

Added to the moves by central banks will be those by SWFs. Though SWFs typically have smaller fixed income allocations, their investments will be sizable, too. Norway’s SWF alone is likely to invest over USD40 billion.

The implementation of the RMB’s inclusion in the SDR basket 10 months from now will also inevitably trigger a significant rebalancing or hedging demand for the Chinese currency, though this, too, is likely to occur gradually.

"By far the most significant effect from the RMB’s inclusion on currency flows will come from multilateral institutions"

Contrary to common perceptions – given that the aggregate SDR assets of the central banks in the IMF member states (around USD280 billion) have an equal amount of SDR liabilities – the RMB’s addition to the SDR basket will not actually trigger a system-wide hedging demand, though some countries that are long or short on SDR may hedge their positions.

Instead, by far the most significant effect from the RMB’s inclusion on currency flows will come from multilateral institutions. The IMF’s own investment account and investment by its Poverty Reduction and Growth Trust would need to be rebalanced to include the RMB.

Likewise, institutions such as the Bank of International Settlements, the African Development Bank, the Islamic Development Bank, the Arab Monetary Fund and the International Fund for Agricultural Development have SDR-denominated balance sheets, which will need to be rebalanced.

The World Bank and Asian Development Bank would also be affected as some of their facilities for the world’s poorest countries are denominated in SDR. The combined size of these multilateral institutions’ SDR-denominated balance sheets is around USD600 billion, so the resulting RMB flows could be over USD65 billion.

Private sector investors are yet to enjoy the same unfettered access to RMB investment as their public sector counterparts, but the sheer speed and extent of China’s reforms in the past year strongly signals China’s intent to accelerate the full opening of its capital account. This may happen a lot faster now than people currently expect.

The ‘ifs’ and ‘buts’ for the RMB are over. For those who are yet to formulate an RMB strategy, now is the time.

This article was first published in The Financial Times on 30 November 2015

Support builds for crucial renminbi move

Jukka Pihlman — Tue, 14 Apr 2015 12:43:12 +0000

Political momentum is building behind an International Monetary Fund (IMF) decision that could boost the global fortunes of the Chinese currency overnight.

Later this year, the IMF will decide whether to include the renminbi (RMB) in its Special Drawing Rights (SDR) – a ‘virtual currency’ made up of a basket of other currencies.

RMB use could soar

If this happens, RMB use around the world is set to soar. Automatically, all central banks would become holders of RMB exposure through their SDR assets, and official reserve currency status would spur those central banks that have not already done so to invest part of their reserves in RMB.

There would be significant RMB hedging activity by some international institutions such as the African Development Bank and Bank of International Settlements, whose balance sheets of over USD300 billion combined are denominated in SDR.

"With the IMF’s official stamp of approval, RMB use would become more legitimate, boosting demand"

With the IMF’s official stamp of approval, RMB use would become more legitimate, boosting demand among investors and private companies. One example could be the Basel III Liquidity Coverage Ratio regulation, which requires the High Quality Liquid Assets held by banks to be in convertible currencies. Whether or not the RMB qualifies is up to regulators, but the IMF’s decision could play a part.

The final decision on the currency’s inclusion in the SDR is to a large extent political, and, judging by recent noises, it now seems significantly more likely that it will go in RMB’s favour.

Further opening of China’s capital account

At the China Development Forum in Beijing last month, Governor Zhou Xiaochuan of the People’s Bank of China (PBOC) publicly pushed for the RMB’s inclusion in the SDR, suggesting that China is now reasonably comfortable about the chances of this symbolic move happening.

For the first time, the PBOC explicitly connected the SDR goal with further opening of its capital account, as Governor Zhou pledged to ease controls, confirming plans to make China’s capital account convertible by the end of this year.

The IMF itself seems increasingly supportive, after rejecting the RMB’s inclusion during the last SDR review in 2010 on the grounds that the currency did not meet the criteria of being ‘freely usable’.

In her response to Governor Zhou, IMF Managing Director Christine Lagarde said that RMB “clearly belongs” in the SDR basket and that the IMF welcomes and shares China’s objective, and “will work closely with the Chinese authorities in this regard”.

"More than USD100 billion of central bank reserves are now invested in the RMB"

In Europe – whose member governments have the largest combined share of the vote at the IMF – the atmosphere is turning increasingly favourable, with Germany declaring officially last month that it supports the RMB’s inclusion in the SDR.

Along with France, Italy, Switzerland and the UK, Germany has also recently joined the China-led Asian Infrastructure Investment Bank as founding members, in a show of political support for the Chinese authorities.

Even before the IMF has made its decision, more than 60 central banks have already invested in RMB despite the fact that, according to the IMF, it cannot yet be reported as part of their official reserves.

By our estimates, more than USD100 billion of central bank reserves are now invested in the RMB, considerably more than in the Swiss Franc, roughly on par with the known amounts of Australian and Canadian dollar investments, and fast catching up with the yen and the pound.

Attitudes to RMB changing rapidly

Central banks in Asia and South America, and many in Africa, have been investing in RMB for a while, but the recent news that European central banks, including the Bank of England, Banque de France, National Bank of Hungary and Swiss National Bank, are following suit shows how rapidly attitudes to the RMB are changing.

Even the European Central Bank is now considering adding the RMB to its reserves, according to media reports. This – along with the rapid growth in the use of RMB for trade and financial transactions – lends significant weight to the argument in favour of the currency’s inclusion in the SDR later this year.

Since 2010, the RMB has seen significant growth in most of the indicators used in determining the ‘free usability’ of a currency, such as international banking liabilities, foreign exchange trade and payments.

"The RMB now hovers between being the fifth and the seventh most used currency for payments around the world"

According to Swift data, the RMB now hovers between being the fifth and the seventh most used currency for payments around the world. We’ve been tracking the RMB’s meteoric rise on our Standard Chartered Renminbi Globalisation Index since the start of 2011, and the RMB is 21 times more internationalised now than it was then.

How the US will play its cards will be interesting – so far, the official statements from Washington have been lukewarm at best. However, it is worth noting that, whereas most big IMF decisions require an 85 per cent majority, effectively giving the US a veto, the SDR decision can be made with only 70 per cent of the vote, if there’s no significant change to the methodology.

Now is the time

If not now, the next SDR review is not till 2020. The IMF can theoretically conduct a review outside of those times, but this would be ill advised and at odds with the IMF’s stated aim to promote broader use of the SDR. Adding additional uncertainty about the timing of an SDR review would seriously hamper the SDR’s prospects of becoming anything more than it is today.

"Given the rapid growth of RMB usage and investment around the world, it seems increasingly likely that the ‘when’ is now"

By contrast, including the RMB this year would instantly make the SDR more reflective of the realities of the new world economy in which China is the largest exporter and has the second-largest GDP. By reducing reliance on the dollar, it would have the added benefit of making the international monetary system more stable.

Christine Lagarde said recently that the IMF’s move is “not a question of if, it’s a question of when”. Given the rapid growth of RMB usage and investment around the world, it seems increasingly likely that the ‘when’ is now.

IMF decision could propel renminbi past sterling and yen

Jukka Pihlman — Fri, 19 Dec 2014 11:29:50 +0000

The Chinese currency’s path to internationalisation has been stellar so far, but something is happening next year which could propel the renminbi (RMB) into the currency stratosphere.

The IMF’s Special Drawing Rights (SDR) – a basket of currencies reviewed every five years – rarely warrants much excitement, but if the RMB gets included in 2015, alongside the dollar, euro, pound and yen, it could boost the currency’s fortunes overnight.

Automatically, all central banks would become holders of RMB exposure through their SDR assets, and the official recognition of the RMB’s reserve currency status would spur RMB investment by central banks all over the world.

"Last time the IMF reviewed the composition of the SDR it concluded the RMB did not meet the key criteria"

Moreover, the sheer magnitude of Chinese exports (China is the world’s largest exporter of goods and services), would send the RMB straight past the yen and the pound to make it the third-highest-weighted currency in the SDR. It is hard to overestimate the importance of this move to the global adoption of RMB.

Last time the IMF reviewed the composition of the SDR, in 2010, it concluded the RMB did not meet the key criteria of being a freely usable currency, but a lot has changed since, making next year’s decision much more finely poised.

Getting into the SDR club

Most of the indicators used in determining the ‘freely usability’ of a currency, such as foreign exchange trading volume and RMB payments have experienced significant growth, with RMB now ranked seventh as a global payment currency according to SWIFT data. According to Standard Chartered Renminbi Globalisation Index, the RMB is now 20 times more internationalised than it was at the start of 2011.

These are all factors, which the IMF will have to take into account. Looking at the official reserves of central banks – another important criterion for admission into the SDR club – the IMF may also want to note that, while the amounts remain relatively low, at least 60 of these central banks have already begun to invest in RMB as part of their reserves.

Bank of England also became one of them this autumn when the UK issued its RMB-denominated bond (the first sovereign in the world to do so), and chancellor Osborne confirmed that the proceeds would be kept as part of the UK’s foreign currency reserves. Another recently confirmed central bank investor in RMB is Sri Lanka’s central bank.

Chicken and egg

However, the IMF faces a classic ‘chicken and egg’ situation: until it confers official reserve currency status on to the RMB, there will be no accurate official data showing the proportion of global central bank reserves invested in the currency.

The only way of gauging the overall amount of RMB investment would be to gain information directly from the People’s Bank of China and through informal surveys of market participants.

The fast-paced adoption of the RMB by central banks and the inclusion of RMB in their reserves – underpinned by the Chinese authorities’ continued and conscious efforts in making the RMB more accessible – could help swing the IMF decision in the RMB’s favour.

The final decision is in part discretionary and politics will invariably play a part, but supporters of the RMB’s inclusion may draw comfort from the fact that changes to the SDR composition are relatively ‘easy’ to vote through.

It’s all about percentages

Most big IMF decisions require a 85 per cent majority, effectively giving the US with its almost 17 per cent share of the vote, the power of veto. However, according to Article XV of the IMF’s Articles of Agreements, the IMF Executive Board can make the SDR decision with only 70 per cent of the vote, provided there is no change to the methodology.

Importantly, the Europeans have indicated by their actions that they are unlikely to stand in the RMB’s way, as long as the technical argument stacks up. Recent reports that the European Central Bank is considering adding the RMB to its reserves, joining France and Switzerland who have already decided to do so, is a highly significant development and shows how rapidly attitudes to the RMB are changing.

The significance to central banks

For many central banks, especially smaller ones and those on IMF programmes, the SDR decision will have huge significance. Many of these countries will already be experiencing increased trade with China, making it increasingly sensible for them to hold RMB reserves.

But the fact that RMB investment cannot be reported as part of a central bank’s official reserves means many are holding back from this logical step. At the very least – even if the IMF chooses not to include RMB in the drawing rights – the IMF will need to address this urgent reporting issue.

"The decision on whether to officially admit the Chinese currency to the club is not one the IMF will be able to postpone forever"

If it doesn’t, by the time the next SDR review comes around in 2020, there will be no official reserve statistics on which to base the decision – despite the fact that by then the RMB is likely to have become the world’s fourth most used trading currency, accounting for close to 35 per cent of China’s trade.

IMF cannot postpone forever

The RMB is very far from challenging the dollar’s dominance as an official reserve currency – more than three-fifths of central bank reserves are still held in the US currency.

But with China now accounting for over 11 per cent of all world trade, and the RMB fast growing in stature, the big decision on whether to officially admit the Chinese currency to the club is not one the IMF will be able to postpone forever.

A version of this article first appeared in FT beyondbrics on 15 December 2014

Central banks catch the renminbi fever

Jukka Pihlman — Wed, 10 Sep 2014 23:00:42 +0000

Adopted at pace by central banks around the world, China’s renminbi (RMB) is now seen by many as a de facto reserve currency – and well underway to becoming an official one.

Central banks have caught the RMB fever, showing strong interest in investing part of their foreign-currency reserves in the Chinese currency, with more than 50 central banks now actively doing so either onshore or offshore.

"Central banks are busy allocating reserves to RMB"

Uptake is strongest in Asia, Africa and South America – regions with fast-growing trade and investment links with China – but even in Europe central banks are busy allocating reserves to RMB.

Earlier this year, Banque de France announced it is active in the RMB market, and in July the Swiss National Bank received a RMB15 billion investment quota from the People’s Bank of China (PBOC), the Chinese central bank. The actions of these two large and sophisticated players are likely to reverberate in the European central-bank community, sparking others to follow.

The international monetary system is becoming ‘multi-polar’

The allocation shift by central banks is all the more remarkable, given that the RMB does not yet qualify for official reserve-currency status. It is a powerful indicator of the great expectations in the RMB as the currency continues on its irreversible path towards internationalisation.

While the RMB is unlikely to challenge the US dollar’s dominance as a global reserve currency any time soon, the international monetary system is rapidly becoming ‘multi-polar’, with the RMB gaining in prominence as a reserve and transaction currency.

"For many central banks, investment in the RMB makes increasing sense"

Currently the world’s seventh most used currency for payments, the RMB is predicted to be fourth by 2020, after the dollar, the euro and the pound. As such, for many central banks, investment in the RMB makes increasing sense, as holding RMB reserves effectively acts as a buffer for covering a country’s import bill from China.

PBOC has helped pave the way for RMB adoption by foreign central banks, giving them special direct access to invest in the RMB interbank bond market. The Chinese authorities have also given central banks preferential treatment in its Qualified Foreign Institutional Investor (QFII) quota scheme, and in the offshore market, the Chinese Ministry of Finance has guaranteed foreign central banks an allocation in auctions of its bonds, a move unprecedented by any sovereign.

Reporting RMB investments

According to the IMF’s rules, the RMB can’t be reported as an official reserve currency by central banks, because some controls on the currency remain in place, which means it’s not technically ‘freely usable’. This means that – in the eyes of the IMF – any sum invested in RMB disappears from the reserves.

Some central banks have started to report their offshore and onshore RMB investments as official reserves anyway, indicating that they believe the criteria of ‘freely usable’ has been met in practice.

This is possible, despite IMF reporting rules, because central banks do not need to disclose the currency composition of their reserves when reporting to the IMF and the IMF does not rigorously scrutinise what is being reported, unless a country is under an IMF programme.

The move by central banks demonstrates the powerful role that both the public and private sectors are currently playing in shaping the RMB’s future.

The IMF and the future of RMB investment

The IMF – with its central role in the international monetary system – is a particularly key player. If the RMB were to be included in the IMF’s Special Drawing Rights (SDR) reserve asset (effectively a basket of reserve currencies), which is up for review next year, it would be a significant step up for RMB internationalisation.

Effectively, inclusion in the SDR would serve as an official acknowledgement of the RMB’s reserve-currency status, and central banks of all IMF member countries would automatically gain RMB exposure through their SDR holdings. It would encourage new central banks to enter the RMB market, and those already there to increase their allocations.

However, even without taking this step, the IMF could play a key role by setting out how RMB investments can be reported ‘officially’ to ensure that smaller central banks and those on IMF programmes – for whom current reporting rules could be an issue – are not put off from investing in RMB. In its approach to the RMB, the IMF should let itself be guided by facts and technical analysis of RMB usage, not by politics.

There is little doubt that the stability of the international monetary system would stand to be vastly improved, if central banks were allowed to manage their foreign reserves in a manner that reduces their vulnerability to external shocks. Given the dominance of China as a global trader, and the rapid internationalisation of its currency, for most central banks this will invariably mean investing a larger proportion of their foreign currency reserves in RMB.

A version of this article appeared in FT beyondbrics on 20 August 2014