As we have expected for some time, the renminbi (RMB) is now odds on favourite to be the next member of the IMF SDR basket. We believe the decision was, unofficially, made months ago and the delay to the vote was indeed just to allow time for the Chinese to put the required criteria in place.
The fact that the IMF delayed their decision until the end of this month, when the board of members vote, has also given members time to air their support, i.e. the UK, US and Europe. Japan has some domestic issues to resolve while they are in their second recession since Abenomics and his quiver full of economic arrows. We look for RMB inclusion as soon as September next year, effective 1st October.
However, the last few months have been difficult for us renminbi bulls as the PBoC has behaved more like a “bull in a China shop” excuse the pun, rather than a “ballerina on a cloud” as other central banks act. The reason for this we think is inexperience in free markets and a misunderstanding of market focus. Broadly, by adjusting the fixing mechanism in such a way back in August not only encouraged longer term investors to cut RMB exposure but also opened the door for speculators to push for a targeted 10% to 20% devaluation. This has been costly, with a drop in the PBoC reserves in August and September, as they intervened to stop excessive weakness. However, October has again seen a rise in reserves, over USD 11bn, as speculators’ ambitions for excessive weakness has been fought back.
The PBoC’s sledgehammer tactics were interpreted as being misplaced and caused some confusion; something other banks are at odds to avoid in a whole new transparent time of central banking. We have always argued that currency weakness is not in China’s interests as they push to boost domestic economic activity and reduce their reliance on export growth.
So, with renminbi inclusion expected what do we think the weighting should be? On a trade weighted basis 20% would appear to be a worthy weight, however, we see that as unlikely, as the weighting criteria also takes note of the currencies use as a reserve currency. We have been thinking around the 10% level, which is more than the Japanese yen’s 9.4% weight but less than sterling’s 11.3% weight.
So the new basket could look something like this: US dollar 37.7% from 41.9%, euro 33.7% from 37.4%, sterling 10.2% from 11.3%, yen 8.4% from 9.4% and Chinese renminbi 10%. Of course this is speculation at the moment and we may have to wait until September 2016 to find out how much weight the IMF puts on the importance of existing reserve status weights in the market place.
Of course the real value of SDR inclusion is the acceptance of China as one of the great financial powers of our time.