Beyond SDR: China’s US$3 Trillion Challenge

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Beyond SDR: China’s US$3 Trillion Challenge

Beyond SDR: China’s US$3 Trillion Challenge by Hayden Briscoe, AllianceBernstein

The elevation of China’s currency to reserve status is symbolically important for the country, but it’s only part of a process that could trigger capital inflows of up to US$3 trillion—and cause some headaches for the country’s financial authorities.

As expected, the International Monetary Fund announced that China will form part of its reserve currency basket, known as the Special Drawing Right (SDR), starting October 1, 2016.

This is a significant step in the internationalization of the currency, and will further enhance the status of the renminbi (RMB) in global currency markets. We think it’s better understood, however, as a small detail on a broader canvas.

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While the RMB’s inclusion in the SDR is likely to stimulate capital inflows as central banks buy more of the currency for their reserve accounts, the inclusion needs to be seen within the context of the opening up of the country’s capital account, which began in July.

In our view, the flow-on effects of capital account liberalization will have a much broader impact on China’s capital markets and on investors in China than the inclusion of the RMB in the SDR per se. While SDR rebalancing by central banks could account for inflows of around US$42 billion, our research suggests that capital-account liberalization as a whole could account for inflows closer to US$3 trillion.

We expect the long-term effects to be positive, but they could cause disruption in markets and pose some challenges for China’s financial authorities in the short to medium term.

US$3 Trillion Looking for a Home

In a little-publicized move, China announced in July that it would allow central banks, sovere