Thursday, July 7, 2016

BIS Banking Department Head Peter Zollner - The Renminbi in the SDR

Here we have a speech by the Head of the Banking Department of the Bank for International Settlements (BIS), Peter Zollner. This speech looks at the upcoming transition of the Renminbi into the SDR currency basket and also the possible future role for the Renminbi in the International Financial System. Below are some quotes from the speech and then a few added comments.


"I will approach this talk by first outlining some basic facts about the SDR and its origins. I will then move to an analysis of the major steps in the renminbi's progress towards becoming an international currency worthy of SDR status. Finally, I will discuss what inclusion in the basket means for the renminbi as a reserve currency. Here, I will also touch on how the BIS has been preparing for this change."

1. Introduction: the SDR

"The SDR is a synthetic currency created in 1969 by the IMF. Its value was initially expressed in terms of gold, as it was conceived in a monetary system where the link between currencies and gold set limits on how far the growing demand for reserves could be met.
With the end of the Bretton Woods system in 1971, the SDR's composition changed to include the currencies of countries with the largest shares of exports of goods and services. From 1974, it comprised 16 currencies (the US dollar's weighting was 33%, a percentage already higher than the country's share of world exports), but in 1981 the synthetic currency was downsized to include just the G5 currencies, being the US dollar, Japanese yen, Deutsche mark, pound sterling and French franc. In 1999, the euro replaced the former European currencies, and the SDR became a four-currency basket."
. . . . . 

2. The renminbi's road to the SDR basket: how did we get here?

"The first aspect to consider when looking at the renminbi's path towards the SDR basket is China's extraordinary economic growth over the last 30 years.
No other country in modern history has achieved such high rates of growth for so long. From 1980 to 2010, China grew at an average rate of 10% every year. In terms of rankings, China is today the world's second largest economy (using GDP at market exchange rates), and when measured at purchasing power parity, it accounts for 17.1% of global GDP, surpassing the United States (15.8%), in 2015.3
This rapid growth was prompted by market-oriented reforms that opened the Chinese economy to the world. Two drivers are often cited as main factors behind this growth, namely exports and investment."  
. . . . . 

3. The renminbi's future role in the international financial system

"All the steps described above have helped the renminbi to establish itself as an international currency, traded both on- and offshore in increasing volumes. In 2013, the renminbi was the ninth most traded foreign currency in the world8 and by 2014, the fifth most used world payment currency in terms of volumes reported by SWIFT.
According to more recent data for offshore foreign exchange turnover in London, daily average turnover in renminbi more than doubled in the last two years (from $19 billion in April 2013 to $43 billion in April 2015).9 Data for Hong Kong also show further growth there, with a daily turnover of $93 billion up by 88% from $49 billion in April 2013.
In terms of bond and equity markets, Chinese markets have reached a considerable size. However, in terms of turnover, these markets remain behind those belonging to the other four currencies in the SDR."
. . . . .
For the renminbi to develop the status of reserve currency, much will depend on whether and how the Chinese authorities will continue to open up their markets and modernise their market infrastructure. It is reasonable to expect that the liberalisation of the last few years will continue, allowing even greater access to the renminbi both offshore and onshore. As we have seen, significant steps have been taken to remove restrictions on investing in the renminbi. On top of this, the authorities are trying to promote the use of the renminbi indirectly through initiatives aimed at supporting the SDR, including a proposal to set up an SDR-denominated bond platform.
. . . . 
"Overall, it is possible that the renminbi's inclusion in the SDR will serve to continue or accelerate initiatives to support the currency. However, doubts still remain. The renminbi is still not fully convertible for capital account transactions. How and when capital controls will be removed will test the macroeconomic resilience of the Chinese economy to uncontrolled flows of funds. Additionally, the coexistence of two exchange rates for the renminbi, one for onshore (CNY) and one for offshore (CNH) transactions, still poses potential operational issues, especially at times when the divergence between these two rates widens."   . . . .
The renminbi's arrival in the SDR basket will not mechanically drive a change in the currency allocation. Other currencies, such as the Canadian dollar and the Swiss franc, enjoy the status of reserve asset without being included in the SDR.
Moreover, even though the SDR was conceived with the idea of diversifying reserve allocations, it is still dominated by the dollar, with that currency's weight well above the weight of the others in the basket. In fact, the renminbi's share of the basket has been accommodated by a larger reduction in the weights of the euro and the pound (by 6.47 and 3.21 percentage points, respectively) while the dollar's weight remains virtually unchanged (from 41.9% to 41.73%).
The BIS and the SDR
To conclude, I would like to turn to the role of the SDR for the BIS, and the Bank's involvement in the renminbi market.
Let me begin this last part by saying that - for the BIS - the SDR has been the unit of account since 2003 when it replaced the so-called gold franc. Furthermore, official institutions are relying on us to provide banking products and services in SDR as well as in all its basket currencies.
From this, it becomes clear that the BIS is undertaking significant efforts to prepare for a smooth switch over to the new SDR basket. We have, for example, acquired direct access to the CNY FX market by installing a trading terminal a few months ago. We are updating our systems, reviewing our procedures and extending our product range.
In this endeavour, we are profiting from the continuous dialogue with our customers, from the tremendous support of the People's Bank of China, from our regional Representative Office in Hong Kong SAR, opened in 1998, and - not least - from our lengthy experience in both the onshore and in the offshore renminbi markets.
For a number of years, the BIS has been investing in the renminbi onshore and offshore markets and has provided customer services in CNH.
In 2004, we started engaging in the Chinese fixed income market as the administrator of the Asian Bond Fund 2, an investment fund launched by the EMEAP central banks which invests in the domestic currency bonds of eight Asia-Pacific markets, including China.
In 2012, the BIS acquired a quota for the onshore renminbi market and started proprietary investments in the CNY. 
Our first CNY product was a BIS Investment Fund invested in CNY government securities, which we launched in March 2014 at the specific request of a number of central banks. As of today, 23 institutions from the Americas, Asia-Pacific, Europe and Africa are invested in the fund.
Recently, we have started providing foreign exchange services in CNY, with CNY sight accounts and deposits to follow. We see the rising importance of the renminbi for reserves managers worldwide reflected in the strength of customer demand for these products - a demand that the BIS will do its utmost to meet, committed as we are to accommodating the full range of evolving central bank requirements.

My added comments: A couple of notes to mention. One is that Mr. Zollner confirms in this speech that China does have interest in issuing SDR denominated bonds. Secondly, he states that the BIS has been using the SDR as its unit of account since 2003 (see items I put in bold type above).
These are a couple of indicators that efforts to expand the use of the SDR do exist and will probably continue going forward. On the other hand, there is nothing in this speech that suggests we are close to the SDR replacing the US dollar as global reserve currency any time soon. Please note this section of the speech:
"Moreover, even though the SDR was conceived with the idea of diversifying reserve allocations, it is still dominated by the dollar, with that currency's weight well above the weight of the others in the basket. In fact, the renminbi's share of the basket has been accommodated by a larger reduction in the weights of the euro and the pound (by 6.47 and 3.21 percentage points, respectively) while the dollar's weight remains virtually unchanged (from 41.9% to 41.73%).
In part, this merely reflects the US dollar's bellwether role in reserves managers' portfolios since World War II. Currently, the US dollar accounts for 60% of global foreign exchange reserves and for one side of almost 90% of all FX transactions.
Globally, demand for dollars is still strong, even after the financial crisis. Indeed, demand for dollars was even stronger during those stressful times.
Among other criteria, an international reserve currency is a currency backed by a big economy with highly developed capital markets, a currency that investors can "trust", especially during periods of stress. "Trust" means that the behaviour of the forces governing the movements in that currency are mostly predictable and determined by market forces."

Added notes: A thank you to Jim Rickards, Willem Middelkoop, Dan Popescu, Trader Stef and many others for a twitter link back to this article. Also, this article will be added to our archive page of articles on the SDR.

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