<img height="1" width="1" style="display:none" src="https://www.facebook.com/tr?id=405009060588537&amp;ev=PageView&amp;noscript=1">

The US dollar has been the preferred currency for denominating oil prices and for settling claims in global trade. Without detracting from the hegemony of the US dollar, the Renminbi (RMB) has undoubtedly inched closer towards becoming an international currency. A direct implication of the RMB inclusion in the International Monetary Fund (IMF) Special Drawing Rights (SDR) basket is that it will compel China to comply with the stringent IMF disclosure criteria.

The Renminbi (RMB) As An International Currency

This will eventually pave the way to further financial reforms helping RMB on its journey towards becoming a truly internationalized currency, even before it acquires reserve currency status. Should China choose to go down the path, it would likely open access to domestic markets for overseas investors. As an investor, you would get direct access to investing in diverse companies in the second largest economy in the world.

The Era of Petrodollar

The Bretton Woods agreement in 1944 pegged the US dollar to gold and all 44 allied nations in turn agreed to peg their currencies to the US dollar. Being as good as gold, the dollar acquired an intrinsic value and became the world’s reserve currency. Later, in 1971, various events led US President Nixon to suspend the dollar’s convertibility to gold. However, the end of the dollar’s gold standard did not mark its demise as the world’s reserve currency. In the early 1970s the US entered pacts with major oil producers in the Middle East, especially Saudi Arabia, to denominate oil prices in US dollars in exchange for US military backing. By 1975, all OPEC (Organization of Petroleum Exporting Countries) countries were denominating oil exports in US dollars. The oil exporting countries used their dollar revenues, the petrodollars, for investment in dollar denominated assets.

Developing countries that needed to purchase oil from the international market saw an intrinsic value in the dollar. To obtain these dollars they began exporting goods to the US in dollars. This allowed the US to effectively print dollars to pay for their imports and continue running a trade deficit with the rest of the world. In the financial market, the steady flow of petrodollar revenues burnished the prices of dollar denominated assets.

However, the decline in the oil prices since June 2014 has lowered revenues of all oil exporting countries. The OPEC cartel has been unable to protect export revenues via production cuts (to increase oil price) due to the refusal by Saudi Arabia, the biggest oil producer. Saudi Arabia can withstand lower oil prices for a longer period as its breakeven oil price is far lower than that of other exporters and it is motivated by geopolitical concerns to make extraction of US shale gas commercially unviable. Nevertheless, the sustained fall in oil prices over the past seventeen months has pushed oil exporters to cover their revenue shortfall by redeeming their global investments.

Embryonic Signs Of A New Reserve Currency

Meanwhile, the growing importance of China in global trade has paralleled its political will to make the Renminbi an international currency. China has long been the world’s largest merchandize exporter and in 2015 became the world’s largest importer of oil. Despite the ongoing structural slowdown in its economy, China will continue to dominate the world economy due to its sheer size.

China has been promoting trade settlement in RMB with its key trade partners since 2009. It launched the ‘offshore RMB’ trading in Hong Kong in 2010 and subsequently a variety of RMB denominated bonds and investment products. The 2013 triennial survey by the Bank of International Settlements ranked RMB as ninth in the world by FX market turnover.

Overall cross-border RMB settlement between China and its trade partners has more than doubled from RMB2.9 trillion in 2012 to RMB5.9 trillion in 2015 (Jan-Oct). China is also in the process of launching an RMB denominated oil futures contract along the lines of Brent futures contract traded in London and WTI futures contract traded in New York. This will allow it to have a greater say in global oil price setting. Russian oil company Gazprom began settling its oil exports to China in RMB from 2014. Russia’s largest commercial bank by assets, Sberbank, has started lending to its corporate customers who are importing from China.

The most recent and also official endorsement for the RMB as a potential reserve currency has been by the International Monetary Fund (IMF). The IMF officials formally announced inclusion of RMB in the Special Drawing Rights (SDR) [1] basket in November 2015. This marks a symbolic shift in the perception of the Renminbi as a potential reserve currency in the future.

Investment Implications

A direct implication of the RMB inclusion in the IMF SDR basket is that it will compel China to comply with the stringent IMF disclosure criteria. This will eventually pave the way to further financial reforms.Improving access for overseas investors to domestic stock and bond markets is a critical step in this direction. If China does follow through on that, then as a retail investor, you will be able to invest in a whole gamut of companies of different sizes and industries in the world’s second largest economy.

You would be able to access shares and Renminbi denominated term deposits. As an investor, you would have more opportunities to diversify your portfolio and directly access new avenues for growth.

Janki Sharma is a freelance economist based in Singapore and writes for Macrovue

[1] The SDR is the IMF’s unit of account and is calculated as a weighted sum of the exchange rates of member currencies versus the US dollar.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

More Posts