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Mark Mobius: China Set To Become Reserve Currency, But Just a Matter of Time
Aspire, Thought Leaders | 07 August 2015
By: Lim Si Jie
Articles (169) Profile

In recent months, China has stepped up a longstanding campaign for its currency to be included as a part of the composition of the International Monetary Fund’s (IMF’s) Special Drawing Rights (SDR).

The Chinese government had campaigned for RMB inclusion in SDRs in 2010, at the most recent of the IMF’s reviews of the SDR structure, but at that time, the bid was rejected. Mark Mobius believes that the prospects for success at the meeting scheduled for October 2015 “appear high”.

What Are SDRs?

SDRs are synthetic quasi-currencies made up of a basket of widely traded currencies. They are used by the IMF for accounting purposes and as a medium for allocating assets among member countries.

SDRs represent IMF’s approval that a currency has the qualities necessary to be an international reserve currency. SDR currencies are automatically regarded as acceptable reserve currencies, whereas other currencies have to meet criteria for full convertibility to have the same status.

For a currency to be included in SDRs, the IMF primarily requires that it be important in terms of its share in global trade, but also that it is “freely used,” a term further broken down into “widely used” and “widely traded.”

Why Is China Aiming For SDR Status?

While SDRs play almost no role in private trade and finance, the four currencies with SDR status—the US dollar, the euro, the UK pound sterling and the Japanese yen—currently make up the overwhelming majority of global international currency reserves. As a knock-on effect of its SDR status, they dominate international bond markets and global financial transactions.

Major Change in Government Attitude

Until recently, the Chinese government had been placing major restrictions on the use of the RMB. The authorities appeared to consider the control that an insulated currency exercises on domestic monetary and fiscal policy to be more important than the potential benefits from full participation in global financial markets.

The government attitude changed in recent years with market-oriented economic reforms and a more outward-looking foreign policy including measures to encourage wide RMB usage.

Potential Benefits for China

Reserve currency status and RMB internationalization could confer a number of significant benefits on China. It could potentially lower borrowing costs and facilitate overseas expansion by Chinese companies, allowing cross-border contracts in major commodities such as iron ore to be priced in RMB, thereby easing foreign exchange risks arising from pricing in US dollars.

Above all else, it could pave the way for a portion of China’s enormous foreign exchange reserves to be redeployed in more economically productive directions. This could stimulate economic growth at the margin both within China and on a global scale.

Other reserve currency countries have much lower reserves relative to their gross domestic product than China does, i.e. the United States is able effectively to operate without reserves at present.

RMB that are at present tied up in currency deposits and Treasury bills could be used to fund overseas investment projects such as China’s ambitious “one belt, one road” and “New Silk Road” initiatives to build trading infrastructure with neighbouring states, as well as private initiatives.

Benefits For the World As Well

Furthermore, the IMF will likely be aware that the prospect of full membership in the world financial system is a significant factor driving the financial reform program in China. The IMF might be reluctant to risk providing ammunition for domestic opponents of the changes, thus complicating a process that appears very much in the interests of both Western investors as well as the Chinese themselves. A strong hint of the direction of IMF thinking came in March with IMF Managing Director Christine Lagarde’s comment that the RMB’s inclusion in SDRs was a question of “when, not if,” but there could be some caution in light of recent market events.

Areas of Concern Regarding China Still Lingers

There are some remaining areas of uncertainty surrounding direct investment in China. In particular, there are lingering fears that a “suspended” capital gains tax could be reinstated and the possibility that a “short swing” law could potentially lead to capital gains from larger investor positions in individual companies being expropriated. These are tempering the market’s enthusiasm for utilizing the new freedoms at present.

In addition, recent actions by the Chinese government to prop up the market and influence market participants could weigh heavily on the ability of the market to attain international respectability. Mark Mobius believes that index creators will likely be very cautious with regards to putting a heavy weighting on Chinese A shares. While Mark Mobius does not expect much in the short term, he believes in the long term that the Chinese market will mature and become an important part of global portfolios.

Si Jie is no stranger to investing having started his journey at a young age. He is heavily influenced by acclaimed investors such as Benjamin Graham, Peter Lynch, and John Rothchild.

Please click here for more information about this author.

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