Convertibility Chinese style (Translation of article published in December 2016 at Linkedin)

                                                                                                                      Maria Celina B. Arraes (1)

News published in the Brazilian and international press at the end of 2016 indicates that the Chinese government intended to impose restrictions on the outflow of capital from China. 

This move comes just two months after the International Monetary Fund's (IMF) decision to include the Chinese currency in the basket of currencies that determines the value of Special Drawing Rights (SDRs), with greater weight than that of the yen and the pound. What would be the connection between these two facts? Controls of capital and international currency?

The inclusion of a currency in the SDR basket means the recognition of the importance of the issuing economy in the global economy and the importance of the use of that currency in international transactions. It should be noted that the terms freely usable currency, international currency, global currency, convertible currency and capital account opening have often been used as almost synonymous, although the concepts are not exactly the same.

The IMF (3) clarifies that a currency can be widely used and widely traded, even if it is subject to some restrictions in the issuing country's capital account of the balance of payments. On the other hand, a fully convertible currency is not necessarily widely used and widely traded, since its use basically depends on the decision of other countries rather than of the issuing country (as is the case with the opening of the capital account) .

A convertible currency may facilitate its use and exchange, but does not ensure the preference of nonresidents to use it in their transactions. The internationalization process of a given currency is evolutionary and market driven. The concept of convertibility is related to official conditions of the international use of that currency, which can be affected by government policies.

A specific case of recognition of the importance of the use of a currency in international transactions is its inclusion in the basket that reckons the value of the SDR.  The first test for the possible inclusion of a currency in the basket is the importance of the export share of the issuing country in world trade. It is considered a necessary but not sufficient condition. After that, the IMF verifies the importance of the currency in the following aspects:

(i)  The participation as component of the official international reserves of the countries;

(ii) The composition of deposits held in international banks by non-banks (data accompanying the BIS); and

(iii) The use of the currency in the issuance of international securities.

Notwithstanding,  the President of the Chinese central bank told the IMF Monetary and Financial Committee meeting, in April 2015, that due to the lessons learned in managing the global financial crisis, China will adopt the concept of managed convertibility. This means that China will reserve the right to continue to manage its capital account in order to limit the risks arising from capital flows and to keep the value of the currency stable and to obtain a secure financial environment.

The inclusion of the renminbi in the SDR basket is the recognition of the importance of the Chinese economy in the global economy, particularly in terms of participation in international trade, as well as of the deliberate policy of gradually opening Chinese financial markets to foreign capital and investment by non-residents. At that time of decision-making in October 2015, this policy was considered sufficient by the IMF Board, although, in financial terms, the renminbi does not have the same importance as the other currencies component of the basket.

The measures announced at the end of 2016 may jeopardize the importance of the renminbi as the dollar's rival, after the IMF's vote of confidence that the Chinese government would continue its gradual policy of liberating the use of the renminbi in international transactions. However, this change in policy is consistent with the announcement by the President of the Chinese central bank at the meeting in April 2015 and will not cause any change in the composition of the basket. Composition reviews take place only every five years and before the next one, there will be enough time to determine whether the controls imposed were short-term or not, and how they affected the use and financial transactions in renminbi.

Finally, it should be emphasized that currency convertibility is a concept related to its official use while internationalization / globalization is related to its use by the private sector. The decision to use the currency internationally depends on a number of factors, not just on the IMF's decision to include the currency in the SDR basket.

(1) Specialist in international monetary system, UNDP consultant for inclusive markets and financial inclusion, Director of International Affairs of the Central Bank of Brazil (2008-2009)

(2) Against capital flight, China hampers remittances from companies abroad. James T. Areddy and Lingling Wei | Dow Jones Newswires, Shanghai

(3) It is notable that the concept of a freely usable currency concerns the current international use and trading of currencies, and is distinct from whether a currency is either freely floating or fully convertible. INTERNATIONAL MONETARY FUND, Oct. 2010, Review of the Method of Valuation of the SDR. INTERNATIONAL MONETARY FUND, Aug. 2015, Review of the method of valuation of SDR- Initial Considerations.