When it comes to foreign investment into Chinese bonds and the adoption of the renminbi as a reserve currency, most US fund managers remain sceptical, while Chinese officials seek to reinterpret what a reserve currency is.
US fund managers argue, essentially, that China wants the world to accept it can be a little bit pregnant. Chinese officials, on the other hand, argue that rules around how the International Monetary Fund (IMF) defines a reserve currency should be adjusted to reflect the reality of emerging markets’ conditions.
China is lobbying the IMF to include the renminbi as part of the basket of currencies comprising the Fund’s accounting unit, called Special Drawing Rights (SDR). Many US fund managers doubt the IMF will agree when it votes on the matter in November.
AsianInvestor spoke with industry executives in the US in mid-June, before the full extent of China’s intervention in its crashing equities market became known. Many outsiders have interpreted this week’s announcement by the People’s Bank of China to ease foreign participation in its $5.8 trillion interbank market as an attempt to reassure markets of its reformist agenda.
Fund managers will need a lot more assurance before they make strategic allocations to Chinese fixed income or view the renminbi as a reserve currency, regardless of whether it is admitted into the SDR.
Lisa Emsbo-Mattingly, director of research for global asset allocation at Fidelity Management & Research in Boston, said renminbi internationalisation required the currency to be deep, liquid and fully transactable.
She noted Beijing has made progress in recent years in developing its bond markets, particularly as a means of replacing bank loans and local government financing vehicles. The bigger, more liquid and more easily tradeable the bond market, the more likely the renminbi should qualify as a reserve currency, she said.
“The problem is you can’t buy and sell those markets,” she said.
Is there room for a compromise?
“You need the currency to be free and convertible,” she said. “A portfolio manager with a global strategy needs daily liquidity.”
That isn’t possible in China today.
You can check out any time you like, but you can never leave
“You can’t have a halfway house,” said William Adams, CIO of global fixed income at MFS Investment Management in Boston. Comments by Chinese officials suggesting the IMF should bend its rules for emerging markets give him pause, he said. “It’s easy to invite money in, but I have to be able to get money out.”
Fund managers in the US say for the renminbi to deserve reserve status, the bond market must liberalise and capital must be able to flow freely. Investors must have confidence in creditors’ legal rights, in banks’ lending standards, and that securities markets won’t be overtly manipulated by the government.
“What are creditors’ rights in China?” asked Andrew Hofer, managing director at Brown Brothers Harriman in New York. “We can’t get a definitive answer.”
Managers see China is moving in a positive direction, but doubt it will open up enough to attract major capital flows. “It’s on the right path. The removal of capital controls is a positive,” said Steve Meier, CIO for global fixed income, commodities and currencies at State Street Global Advisors in Boston. “But we don’t yet see the level of disclosure or transparency around bank balance sheets.”
He agreed that the question around capital controls is binary. “It’s a yes or a no,” he said, suggesting Beijing was still a couple of years away from relaxing its grip on flows.
Freely convertible, or just freely usable?
Not all fund managers agree with this view. Michael Kelly, head of multi-asset at PineBridge Investments in New York, is an eager buyer of China bonds through existing approved channels. He doubts China will meet the IMF’s checklist for including the renminbi as an SDR currency, namely because China hasn’t internationalised its bond market or freed banks to set lending and deposit rates. But he thinks a compromise will be found in the near term.
“Convertibility is not the criteria,” Kelly noted of the IMF’s definition of a reserve currency. “It’s being freely usable. We don’t think China has to open the capital account in order for its currency to be usable enough to qualify as an SDR reserve unit.”
Moreover, SDR inclusion would have a huge boost on usage of the renminbi, even if it’s just the offshore version.
“There will be big flows into Chinese bonds once the big issues with the renminbi are officially signed off by the international investment community,” said Jeffrey Knight, global head of investment solutions at Columbia Threadneedle Investments in Boston.
While he suspects those conditions won’t be met for several more years, “If China gets the renminbi into the SDR, that would be a key step toward a more advanced local government bond market, and to making the renminbi a competitor to the US dollar as a currency for commerce. It would be an indicator of financial flexibility, and it would offer reassurance that China is contributing positively to the global economy.”
SSGA’s Meier added: “SDR inclusion would be more than just a symbol. It would give China a bigger say in the economic development of the region.”