RCIF | Research Center for International Finance
Chinese Academy of Social Sciences
Policy discussion No. 2016.002
The Impacts of RMB Cross-border Settlement on China's Economy
XU Qiyuan
In Tokyo, I have frequently been asked about two renminbi (RMB) internationalization concerns: the RMB's acceptance as a special drawing rights (SDR) currency and future RMB exchange rate reforms.
The first issue with the RMB receiving SDR status is that the International Monetary Fund (IMF), rather than China, is the biggest winner. Before the RMB received SDR status, it was being gradually forgotten both by policymakers and academics. It's not important at all in the international financial system. China's great interest in SDR in recent years enabled the IMF to very successfully market SDR to China. In China, news about SDR is everywhere.
......
Liquidity
I would like to mention two types of liquidity in connection with free usability. The first is internal liquidity. For example, when a country such as Thailand wants liquidity, e.g. U.S. dollars, it will take out some SDR quotas and ask the IMF for an exchange. The next step is to put that money into the foreign exchange market for interventions to stabilize the exchange rate, etc. Countries such as the United States are responsible for exchanging their SDR so that Thailand can receive U.S. dollars to manage internal liquidity, for example. It is a duty to which China will now be subject.
......
SDR and exchange rate reform
The third issue is the meaning of SDR to RMB exchange rate reforms. Since 2005, China has changed the RMB exchange rate regime from hard-pegging to the U.S. dollar to soft-pegging it. Although it is soft-pegged, the RMB remains fairly stable relative to the U.S. dollar. If the RMB attains SDR status while remaining pegged to the U.S. dollar, the U.S. dollar's share in SDR indeed will be indirectly increased. This also means that the SDR will become more volatile from the perspective of non-U.S. dollar countries such as Japan and the European Union (EU).
......
Cost of SDR entry
The fourth and final issue is the price China will have to pay for the RMB to qualify as an SDR currency. From a long-term view, China should open its capital account and carry out exchange rate reform. But from a short-term view, liberalizing the capital account is risky and not particularly urgent, while exchange rate reform is indeed urgent. An insightful working paper published by CEPII offered two simulations. One assumes the RMB joins the SDR in 2015 and the other in 2020. These two scenarios are very different. The 2015 scenario limits the shock, whereas in 2020, the shock will be much greater. Two factors contribute to the greater shock. First, with regard to RMB interest rates, a big spread exists between the RMB interest rate and the U.S. dollar, Japanese yen, and euro. With this background, if the RMB enters the SDR, the interest rate curve and exchange rate for the SDR will suddenly jump. Second, as the weighting systems in 2015 and 2020 will be different, the later the RMB joins the SDR, the larger ratio of RMB will be in SDR, consequently, a bigger jump of SDR's interest rate and exchange rate will appear. To ensure stability in the interest and exchange rate curves, the sooner the RMB joins the SDR, the better.
......