China: Subdued internationalization of the RMB so far – Deutsche Bank

Research Team at Deutsche Bank notes that for the first time, the IMF this week will publish the COFER reserve allocation for the RMB and expects that the share should be small at 1-2%, reflecting the subdued internationalization of the RMB so far.

Key Quotes

“In our view, reserve inflows will also remain too limited to promise a meaningful offset to outflow pressures, though the new data will bear close monitoring.”

“Historically, the IMF starts breaking out specific currencies when the allocation reaches about 1.5%, which implies around $120bn in CNY reserves. Consistent with this, IMF and BIS surveys in 2015 concluded that reserve managers allocated about 1% to CNY, which share probably rose slightly in 2016. PBoC statistics, lastly, report foreign bond ownership of $120bn at end-2016.”

“Not all of this is attributable to central banks, but when factoring in small equity holdings, not least by Norges, total reserve holdings probably lie between $100-140bn. This estimated COFER allocation is likely the lower bound for the renminbi’s share in global reserve assets since sovereign wealth funds not included in COFER likely have a somewhat higher (equity) allocation to China. The Invesco IGSAMS survey of 2016 indeed found that sovereign institutions, including SWFs, held about $150bn in CNY. Nonetheless, as a reserve currency the RMB still ranks with AUD, CHF, and CAD.” 

“Yet although the current allocation to CNY is probably small, the new data series may re-focus the market’s attention on an old question: when will the RMB become a reserve currency, and will the process offset the bearish pressure from pent-up outflows? Our view remains that global reserve managers are unlikely to reallocate meaningfully in the foreseeable future.”

“About 80% of official reserves are held in ‘liquidity tranches’ used for FX stabilization. In theory, reserve managers should hold about 20% of their liquidity in RMB, given the size of China’s currency bloc. The main reason they don’t is that there simply aren’t enough liquid assets to own. A 20% allocation of COFER reserves of $8trn (ex-China) would imply central banks owning almost the same share of China’s $9trn bond market. While Chinese policy-makers have actively tried to attract foreign reserve managers, this degree of foreign ownership without material controls is unrealistic. In turn, the prospect of shifting regulation, along with poor valuations, may be the main reason reserve managers don’t invest meaningfully in Chinese bonds.”

“China’s $7trn equity market could provide extra depth, but central banks will be reluctant to overweight China relative to benchmark indexes. On that front, MSCI last week once again opted against wider inclusion of Chinese A shares into the MSCI EM benchmark, the new weight of 0.5% implying only $1-2bn of inflows. In the long-term, full inclusion into the MSCI and FTSE benchmarks could entail more than $600bn in equity inflows. In the near-term, however, Chinese policy-makers appear in no rush to create the required conditions.”

“Hence, reserve managers’ demand for Chinese assets will come nowhere near offsetting the outflow pressure on the capital account. The impetus will likely need to come from institutional investors, with central banks to follow slowly.”