Wednesday, December 2, 2015

IMF Welcomes Chinese Yuan. So What?

CEIBS Professor Xu Bin Explains

Q: Did the IMF make the right decision? Does the RMB deserve to be in the basket? Or, has the IMF ignored standards or bent rules to accommodate it?
A: It was the right decision for the IMF to make. The IMF reviews the basket every five years. Arguably the RMB may not have met all the requirements for entering the SDR basket now, but it is anticipated that the RMB will meet all these requirements within the next five years. I think the IMF made a forward-looking decision, which is strategically sound. 

Q: There is a view that the IMF is betting China will change and ease restrictions in the financial sector once it becomes a reserve currency. Do you agree? Is China likely to make the currency fully tradable on capital account?
A: China has been moving in the direction of making the RMB convertible and the capital account more open. However, the process has been rather slow. The entry of the RMB into the SDR basket will provide a significant stimulus to this process. Making the RMB a reserve currency is a top priority of the Chinese government because it is in its long-term interest, so we should not underestimate the real effect of this SDR decision, which may just appear symbolic at this point.

Q: Will this decision help or hurt the Chinese economy, including exports, at this time of low growth? What do you think of predictions that the decision will boost demand for the Yuan in the international market by $600 billion?
A: At this point, this SDR decision has little effect on the Chinese economy. However, I believe China's central bank will make great effort to maintain stability of the RMB-USD exchange rate in the near future (say the next 18 months) to eliminate the expectation of RMB depreciation against the USD. In the medium term, I believe China's central bank will make the RMB exchange rate more flexible (i.e., increasing the bands) as intermediate steps for the RMB exchange rate to float. This entry of the RMB into the SDR basket, which will become official on October 1, 2016, will not immediately bring a significant added demand for the RMB in the international market, so there will not be pressure for the RMB to appreciate. But in the long-run, if China is able to create more RMB products for foreign investors (such as RMB-denominated international bonds), then there will be a boost in the demand for Yuan in the international market.

Q: Is there a fear that it may result in more Chinese funds escaping to foreign countries?
A: Capital outflow from China to other countries is already a large amount, especially in the past two years. The entry of the RMB into the SDR basket will alleviate the degree of capital outflow as the Chinese government will make great effort to stabilize the RMB-USD exchange rate in the next 1-2 years. However, in the medium (5 years) and long-run, as China opens its capital account and the RMB rate becomes more flexible, there will be increasing risks of capital flight if China’s real economy continues to slow down.

Q: What are the implications for the U.S., European Union and Japan, whose currencies are in the SDR basket?
A: As China becomes more and more involved in international businesses, it is inevitable that the RMB will be increasingly used in international commerce. So it is wise for the US, the EU, Japan and Britain to engage with China for their own benefits. A more open China will provide more business opportunities for all countries, especially for the advanced countries whose financial sectors have the comparative advantage.

Q: What do you think about the effective date of October 2016 and the SDR weightage of 11 percent? Will this really enhance the RMB's status as an international currency and expand its use?
A: The decision on the RMB's entry into the SDR basket now and its implementation in October 2016 are largely symbolic. What really matters is how China takes this opportunity to speed up its financial opening process. We are not sure about how far the Chinese government will go, but we are sure that this SDR decision will move China more towards a financially open economy. This is positive both for China and for the world.

Professor Xu Bin is CEIBS Associate Dean (Research), Wu Jinglian Chair in Economics, Professor of Economics & Finance