1st December 2015
The International Monetary Fund has designated China as a global reserve currency. AXA Investment Managers analysis suggests the move should attract $600bn worth of investment into China in the next five years. The fund manager also says that the move will strengthen the relevance of the IMF’s ‘Special Drawing Rights’ Basket of currencies with the Renminbi joining the Euro, the Yen, sterling and the dollar.
The Axa IM note adds: “Having an emerging market (EM) currency in the SDR will also improve the IMF’s representativeness in the global economy, as the political push for EMs to gain more voting rights has been repeatedly vetoed by the US congress. As for China, the IMF’s seal of approval is an important recognition of the growing importance of the RMB as an international reserve currency. We think today’s decision will encourage China to speed up RMB internationalisation and the opening of the capital account. Both will help China to continue to integrate its financial system into the world.”
” It is worth recognising that, as a standalone event, the SDR inclusion does not bear much immediate significance. According to the new weighting calculation, the RMB will command a weight of 10.9% – slightly below our prior estimate of 14%, mainly at the expense of the euro and sterling (see chart below). We estimate the rebalancing of the SDR portfolio will (only) drive an inflow of around $30bn over the span of a few years, and the process will not start until October 2016.
“Where we think yesterday’s decision can have a significance is through a number of indirect channels and over the medium term. In particular, we think the SDR inclusion will raise the RMB’s profile as a global reserve currency, prompting central banks, sovereign wealth funds and reserve managers to allocate towards RMB assets for their portfolio. In addition, private investors, such as pension funds and insurance companies, will also likely seek exposure to the yuan as China opens up its domestic capital markets. Aggregating all three groups of investors – the IMF, official investors and private sector – we think that total inflows could amount to around $600bn over the coming five years. Below is an update of our capital flow estimates (for more details, please see RMB: assessing the chance and impact of SDR inclusion).
“As for the exchange rate, we continue to think the most likely path for the RMB in 2016 is one of relative stability, albeit with a mild depreciation bias against the US dollar. Even though the RMB’s inclusion in the SDR could drive significant capital inflows over the medium term, FX movement in the near-term will be dominated by data flows, investor sentiment and policy divergence between the People’s Bank of China and the Federal Reserve. In that regard, elevated macro uncertainty and rising financial risks will likely keep a downward pressure on the yuan, although we think the authorities will intervene, if necessary, to prevent a large devaluation. We think the official strategy is to keep the FX market orderly and stable, but not fighting the trend.”
“This is an important step on a long term trend of opening up China’s capital account. The implication for long term investors is the internationalisation of the RMB allows increasing exposure to the Chinese capital markets as they develop. The developments such as the Stock Connect and mutual recognition represent a move forward from the traditional quota based systems and we would expect these to extend to bond markets as well over time. As the RMB becomes more fully convertible the flows in and out of China will become more significant and the cross border capital flows easier. With China already the second largest economy in the world and with the shift from a traditional banking model to a more western capital markets based system of financing, the opportunities for western investors to come in while Chinese investors diversify outward will represent a huge opportunity over the next few years.”