RMB’s rise to reserve currency status accelerates

Since China began to liberalise its currency last year, debate has raged over whether and when renminbi will become a major reserve currency in its own right. The ongoing sovereign crisis and the recent downgrade of the US's credit rating by Standard & Poor's appear to have accelerated the pace of change in the composition of central bank reserves.

"The US downgrade in August was a really key driver of interest in renminbi. In the days following the downgrade we had several enquiries from central banks about what they might be able to do in the currency. It's inevitable the world will look towards a strong country for a new reserve currency and China is one of the biggest economies in the world at the moment," says the head of emerging markets trading at one European bank.

Nigeria, Chile, Thailand, Brazil and Venezuela are among the first countries whose central banks are understood to have begun efforts to include renminbi in their reserves portfolios. But economists remain uncertain about how soon renminbi will become a serious international currency, despite the Chinese authorities' recent efforts at liberalisation.

"There are few doubts that the renminbi will become a major global currency and that at some point in time it will account for a considerable proportion of central bank reserves. However, for the time being it is not free floating or convertible, and this carries considerable risks if you are going to use that currency as a significant part of your reserves. Five years forward, China will be a dominant force in the world economy and the yuan could be freely traded. But until then there is a good reason for central banks to be cautious," says Philip Shaw, chief economist at Investec in London.

Attaching a specific time horizon to the growth of renminbi is difficult, as it will depend on the rate at which the Chinese economy evolves, Shaw believes. But five years appears to be optimistic. "It's still an emerging market currency, even if a very powerful one in the medium term," he says.

The uncertainty hasn't stopped some emerging market central banks taking the plunge. The Central Bank of Chile reported in its September monetary update that 0.3% of its international reserves are now held in renminbi. And in a statement on September 5, the Central Bank of Nigeria (CBN) confirmed it had finalised arrangements to diversify its reserves to include renminbi, in addition to dollars, euros and sterling.

"Given the growing economic importance of China in the world, and the increasing trade flows between the two countries, the CBN initiative is expected to secure a strategic advantage for Nigeria in its economic and trade relationship with the People's Republic of China," the central bank said.

While not all central banks are at the point of investing in renminbi, the ongoing crisis and the early moves of some institutions has highlighted the issue and the potential value to be gained by diversifying into renminbi.

"The issue is arousing the interest within central banks – the question is on the time horizon of this diversification process. The steps already taken by a number of central banks worldwide are a declaration of intent. But as long as the Chinese authorities do not allow the free-floating of their currency, in a democracy where the central bank is accountable to the public, diversifying reserves into renminbi would be a hard sell," says a risk manager at one central bank in Europe.

But some market participants continue to believe renminbi is set for reserve currency status sooner or later. Over the past two months, FX Week online readers were asked in an industry poll whether it will become a major reserve currency within the next 15 years; a view taken by HSBC chief executive Stuart Gulliver in a speech in June.

In response, 38% said both renminbi and the euro are set for reserve status, while 25% of respondents believe only renminbi will become a major reserve currency. But 30% of poll respondents suggested the dollar would remain the only major reserve currency in spite of recent economic troubles in the US.

"There is a constant debate on the dollar's future as a reserve currency, and talk about what are the potential alternatives. Even if renminbi is one of them, for the time being there are few feasible alternatives to the dollar given the deep liquidity of the US currency," says Daniel Hui, senior FX strategist for Asia at HSBC in Hong Kong.

Moreover, renminbi diversification will be done on an incremental basis, Hui believes, with central banks gradually learning how to manage the currency as part of their reserve portfolios. The growth of offshore renminbi since it was established as a currency last year is promising, he adds.

"The offshore renminbi market is quite liberalised and truly deliverable, and that would form the basis for a future market. The process is happening now and it's having a real impact on the FX market. The fact you can access offshore renminbi in Hong Kong is something you couldn't have expected not long ago," Hui explains.

This article was first published on FX Week.