How China’s race to reserve currency status will rock markets
By Luca Rossi 23 Jun, 2015 at 13:53
The inclusion of the Chinese renminbi into the basket of IMF’s reserve currencies will radically transform global markets and developing countries’ central banks policies.
That's according to Ashmore’s head of research Jan Dehn, who shared his views during a press roundtable on Tuesday.
Dehn believes China, which underwent a market correction over the past 10 days, is planning to attract long-term institutional investors, including foreign central banks, into its domestic market.
This is why labelling the renminbi a global reserve currency is crucial - it means that central banks, and not just short-term retail investors, will be buying the currency.
‘97% of all global reserve currencies are in Japanese yen, euro, British pound and US dollar. All these four central banks are currently printing money to stimulate their economy. This means that the world will be soon in serious shortage of global reserve currencies,’ he said.
Dehn thinks China is actively and aggressively responding to this major trend initiated by developed markets, which is likely to cause an appreciation of the renminbi.
‘China knows it sits on a time bomb. Developed markets are trying to find their way out the crisis by creating inflation and weakening their currencies rather than implementing structural reforms. This is going to make the renmimbi appreciate to an unsustainable level.’
The Chinese authorities' plan is therefore to make international investors tap into its currency as soon as there is a more pronounced shift away from QE-driven currencies, according to Dehn.
A new sovereign wealth fund
Dehn said China would no longer need its foreign exchange reserves once its reaches global reserve status. He compared it to the US, which currently has hardly any foreign exchange reserves.
‘This means that China's foreign exchange reserves, nearly $4 trillion, will become a sovereign wealth fund, which is not going to be invested in US dollar, but in global infrastructure, private equity and alternatives.’
‘It’s therefore very likely that China, over the next few years, may become a steady seller of US treasuries and buying other assets,’ he added.
‘Going forward, this will be a much larger investment programme involving sovereign wealth fund-type activities all over the emerging world. Other EM central banks such as Mexico’s and India’s will be looking very closely at what China is doing and trying to join the global reserve currency club.’
Financial big bang
Looking at Chinese fixed income, Dehn thinks the municipal bonds market is the most exciting part of the sector at the moment. He highlighted that currently China has 11 trillion RMB ($1.77 trillion) of local government debt, mainly on banks' balance sheets.
This debt has been swapped into tradable bonds in order to transmit monetary policy signals down to local government level and manage the country’s macro economy.
‘Next step is to stimulate consumption - China has a savings rate of 49%, which represents a great room to increase spending. They will have to reduce people's precautionary savings putting bonds into their portfolios as at the moment they can just invest in property and stocks,’ he said.
Increased consumption, Dehn argued, will drive imports and worsens the country’s account surplus. ‘The country is opening its domestic market to foreign investors to offset this trend. The market cap of the equity and bond market in China is $15 trillion, which almost equals US GDP.’
‘This is the biggest big bang in world's economic history - never has a market the scale of the US economy been opened to international investors.’