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Five Driving Forces for Hong Kong’s Offshore RMB Market following the Currency’s Inclusion in the SDR Basket

On October 1st, the RMB was officially included in the IMF’s Special Drawing Rights (SDR) basket of currencies. With a weight of 10.92%, the RMB trails only the dollar and the Euro among the five international reserve currencies. The RMB joining the SDR basket is a major event of global financial management as well as an important milestone of the currency’s internationalization. As a result, the driving force of RMB internationalization will expand from China’s financial regulatory authorities to global multilateral institutions. The IMF’s endorsement of the RMB as an international reserve currency will help speed up the pace of internationalization, bringing new opportunities to Hong Kong’s offshore RMB market.

1. The RMB’s international reserve currency function will help restore market confidence.

Technically, the SDR is not a truly global supranational currency, with only some 200 billion dollars of value. Therefore, the direct impacts of joining the SDR basket will be relatively limited. That said, the RMB will improve the representativeness of the SDR and increase its influence in foreign reserves management. In this regard, the RMB joining the SDR basket will help fulfill the SDR’s long-term and irreplaceable potential as a positive influence in global financial markets.

In the long haul, with SDR status, the RMB will establish itself as an international currency, transforming from an important global payment currency to a major reserve currency. Meanwhile, the RMB will also be increasingly widely used in trade and investments, becoming a major investment and financing currency and one in which commodity trading is denominated. The RMB will thus assume an important role in the global financial structure.

The development of the RMB as an international reserve currency will help restore market confidence in two aspects.

The first aspect is the foreign exchange mechanism. After joining the SDR, as a new international reserve currency, the RMB’s foreign exchange mechanism will become more market-oriented. In particular, the RMB’s exchange rate will become more flexible, increasingly being determined by changes in market supply and demand under the current and capital accounts. Increasing influence of market forces on the RMB’s exchange rate will help improve the predictability of the currency, supporting market confidence.

The other aspect has to do with market supply and demand. After the RMB joins the SDR basket, international capital inflow into mainland China may increase. The 188 members of the IMF will be able to hold RMB assets to meet their international payment and borrowing needs. Central banks and monetary authorities will also likely increase their RMB assets, pushing up the share of the RMB in global foreign reserves.

As per our observation, the investing style of central banks and sovereign wealth funds is clearly different from that of individual investors. There need for diversification is stronger, in addition to important considerations of liquidity, security, and total return. Fluctuations in exchange rates is but one factor, more important are diversification, the availability of a variety of investment choices, market breadth and depth, and convenience of trading. The RMB, as the first emerging market currency to join the SDR basket, can effectively meet these needs. Central banks and sovereign wealth funds will gradually increase their holdings of RMB-denominated assets and become important drivers of RMB internationalization.

In addition, as the occurrence of black swan events in financial markets is becoming increasingly frequent, the risks of sterling and Euro-denominated assets have risen. In the new round of portfolio rebalancing, due to the RMB being a high-yield currency, RMB-denominated assets will attract the attention of investors.

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Content provided by Bank of China (Hong Kong)
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