The confirmation earlier this week of the inclusion of the renminbi (RMB) into the special drawing rights (SDRs), a reserve asset managed by the International Monetary Fund (IMF), is a major milestone in China’s mission to globalise its currency. The decision has been a long time coming and has effectively granted the status of global reserve currency on to the RMB.
At first glance, it appears the kind of development that should be of primary interest to central bankers, who will be thinking about how to reallocate their reserves to match more closely the basket of currencies that makes the SDR. With a little reflection, however, it should be clear that the IMF’s move is a reminder for companies across the world that the RMB needs to be part of their business strategy.
The reasoning is as follows. The RMB’s newfound status as a reserve will, over the medium term, boost demand for the currency among central banks. A recent Bloomberg poll of reserve managers gave a median prediction that 10% of global foreign exchange reserves will be held in the Chinese currency by 2025.
To put this into perspective, there is currently US$7.8 trillion worth of reserves globally outside of China. So if such a diversification were to take place today it would require nearly US$800bn to go into RMB-denominated assets.
As countries hold more of their wealth in the RMB, it sends a powerful sign to businesses that the currency is a viable store of value. The result will be an uptick in companies using the currency to settle international trade.
At the same time, China’s capital outflows are growing rapidly, as local investors diversify into foreign assets. Outbound investment by businesses and individuals is expected to generate US$1.5 trillion worth of outflows by 2020.
The RMB will therefore be stuck in the middle of a supply and demand tug-of-war that is set to increase the level of two-way volatility in its exchange rate. It will be a sharp turnaround from the situation just a few years ago, when the Chinese currency was considered by many to a one-way bet on appreciation.
A sign of what’s ahead
Any company that does business with China should take note of this upcoming chain of events, as movements in the RMB are set to become a consideration that cannot be ignored. Different companies however, will have different areas of focus.
A manufacturer, for example, that sources some of its parts from China may well be mostly focused on the exchange rate, which could influence the cost of some of its components. A foreign firm that invests in China, while directly trading with local customers, will need a more advanced currency strategy, which not only takes into account the value of the RMB, but also the liquidity conditions to ensure that it can get hold of enough cash to meet its obligations.
As volatility in the RMB increases, the costs of eschewing currency considerations could be considerable – even for companies that have only a small direct exposure to China. As the world’s second-largest economy, it has a huge influence on everything from the health of emerging markets to the price of commodities. A significant shift in the outlook for the RMB could therefore have a substantial impact on financial markets, trade flows, and even international relations.
We got a taste of the RMB’s importance over the summer, when the People’s Bank of China (PBOC) increased the currency’s flexibility via a one-off adjustment that led to a sharp, but short-lived, devaluation. Financial markets went into a spin, and the media was quick to announce that China had “fired its first shot in a global currency war”.
The panic quickly died down, and although the central bank’s move was a shock to some, for those who pay close attention to the RMB, it was simply the latest step in China’s long-term goal to introduce more market forces into the value of its currency.
There’s no one-size-fits-all RMB strategy that is applicable to all companies. Every business needs to find an approach that fits its circumstances. But what’s clear is that despite encouraging signs indicating companies want to do more business with China, many firms are missing out on the chance to get ahead of their rivals by including the RMB into their business planning. According to HSBC’s RMB survey this year, only 22% businesses are using the currency to settle trade.
The trend, though, is clear – the RMB is on track to enter the top tier of global currencies and the IMF’s SDR decision is only the latest reminder. The imperative for businesses the world over it is to make the currency a key part of their foreign exchange considerations. Those who fail to do so, could find themselves playing catch-up with their competitors.
*This article previously appeared in ‘The Nation‘ in Thailand.
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