Small pips in a currency have the ability to make an entire country’s goods cheaper or more expensive to the rest of the world in an instant.
And in this age of international finance, the cost financing and value of debt balances can swing massively.
This brings us to China, the world’s second-largest economy, where the country’s currency — the renminbi — could see its status in the world change.
Since then, investors and companies have been concerned about what exactly China means for growth prospects. Some have even attributed their weaker third-quarter numbers to it.
But there’s another, largely overlooked thing financiers should keep an eye on:
China wants to get its renminbi into the International Monetary Fund’s reserve-assets classification known as the special drawing rights, or the SDR. And its inclusion or exclusion could have major ramifications in the global markets.
On Wednesday, Lombard Street Research hosted a conference partially dedicated to analyzing the impact of China’s liberalization on financial markets. Several speakers specifically mentioned China’s desire for the yuan’s inclusion in the SDR as a key thing to watch.
Though inclusion in the basket may not immediately strike investors and casual onlookers as that important, that’s definitely not how China sees the situation, according to Diana Choyleva,Lombard Street Research’s chief economist and head of research.
“The IMF is about to decide whether to include the yuan in its SDR basket,” she said at the event. “As far as I’m concerned, if the yuan is accepted, and the omens are good now, this will mark the start of China’s full integration into global financial markets.”
Choyleva went on to delineate what exactly the inclusion or exclusion of the renminbi would mean for the markets.
“If the yuan goes in the basket, then the likelihood is that the Chinese would prefer a gradual depreciation of their currency against the US dollar,” she said. “And this is good news because it allows time for the real income gains in the West to be spent and potentially for us to get into the positive scenario.”
But if the yuan is not allowed in the SDR, Choyleva said:
“The Chinese leadership is not going to wait another five years for the West to deign to accept them. And they will not be so keen to be such a responsible global citizen. Because out of the major economies, the only currency that’s seriously overvalued is the yuan, and that’s the only one that hasn’t engaged in any major effective devaluation. […] If the yuan is not accepted in the SDR, they will go for a one-off large devaluation and that would then be … a financial crisis, specifically, a real-economy crisis with the resulting impact on the … markets.”
This may seem sort of intense for a membership that doesn’t even seem important to Western investors. For China, however, getting the renminbi into a currency basket made up of the US dollar, the euro, the Japanese yen, and the British pound could indicate recognition of the currency’s global political importance.
“I did an interview yesterday [where] I was asked, ‘but, surely, the SDR is of no importance,'” Choyleva said at the event. “But actually, it is of symbolic and political importance. And I would argue, much like China’s entry into the World Trade Organization in 2001 changed the global economy fundamentally, China opening up the capital account and allowing the market to determine interest and exchange rates, will be as transformative for the world economy.”
Interestingly, back in August when China first devalued its currency, some analysts pointed out that Beijing’s unwavering desire to get its currency into the SDR could have, at least partially, been the catalyst, citing similar reasons as Choyleva.
“The Chinese government wants desperately for the [IMF] to include the yuan in the basket of currencies that comprise the IMF’s reserve assets that are known as special drawing rights (SDR),” Wells Fargo global economist Jay Bryson wrote in a note to clients at the time. “Joining the US dollar, the euro, the Japanese yen, and the British pound in the SDR would be an acknowledgment that the yuan has become an international currency.”
Ultimately, the IMF is set to decide whether to include the renminbi in its SDR basket sometime in November. And, as UBS legend Art Cashin noted back in August, “If that approval were given, we could be looking at shifts in the trillions of dollars.”