In late 2016, something happened that a lot of people thought would be a giant step in the process of the internationalisation of the renminbi, China’s currency.

At the end of September 2016, the renminbi was added to the International Monetary Fund’s (IMF) Special Drawing Rights (SDR) currency basket.

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The SDR is an international reserve asset comprised of a basket of major global currencies, created by the IMF in 1969 to supplement the existing official reserves of IMF member countries. SDRs are allocated to member countries in proportion to their IMF quota.

(To explain… each member country of the IMF is assigned a quota, based broadly on its relative position in the world economy. A member country’s quota determines its maximum financial commitment to the IMF, its voting power, and has a bearing on its access to IMF financing.)

The general perception at the time was that the inclusion of the renminbi in the SDR would be a big step in China’s integration into the global financial system. And that after being made part of the SDR basket, the renminbi would be well on its way to join the U.S. dollar, the euro and the yen in the exclusive club of global reserve currencies.

China is closed… but opening

China is the second largest economy in the world. With a projected nominal 2017 GDP of US$11.8 trillion, it’s more than double third-place Japan’s US$4.8 trillion. Yet despite its economic heft, China’s financial markets continue to open to outside investors only very slowly.

We’ve written extensively about the inclusion of China’s mainland A-shares in global benchmark equity indexes, and how the bond markets are next. This is progress for the stock market.

But for a broader gauge of global integration, we can look to the renminbi – specifically, at the proportion of total global international currency payments that are denominated in renminbi.

You can measure this figure using SWIFT.

SWIFT is a platform used by over 11,000 financial institutions in more than 200 countries for financial communication, primarily used by banks to communicate instructions related to cross-border transfers.

Through SWIFT, banks, custodians, investment institutions, central banks, market infrastructures and corporate clients, connect with one another by exchanging structured electronic messages to perform common business processes, such as making payments or settling trades.

SWIFT has become the standardised international payments system. So, when assessing the percentage of international payments that are done in renminbi, we look to SWIFT to provide us the answers (see the chart below).

In the past two years, the renminbi share has actually fallen, from 2.09 percent in June 2015, to 1.98 percent in June 2017, as it declined from the fifth to the sixth most widely-used currency.

And when it comes to payments to China, the U.S. dollar remains the major currency of choice. In fact, 98 percent of payments (by volume) sent from the U.S. to China are in dollars.

It’s not for lack of trying

Internationalising the renminbi is a priority for the Chinese government, which when setting out to achieve an objective, usually gets it done. That it’s made so little progress here is surprising.

The government has designated cities in 23 markets as renminbi clearing centres, the latest addition being Moscow. These are locations where the renminbi is used to settle trade and financial transactions directly.

By comparison, in 2013 there were only 4 cities housing clearing centres; Hong Kong, Macau, Singapore and Taipei.

Still, the vast majority of renminbi clearance is done in Hong Kong, where over three quarters of payments are settled.

And when it comes to major western renminbi financial centres, the U.K., the second-largest clearing centre after Hong Kong, has seen its share of renminbi volume decline from 6.23 percent to 5 percent of the total global renminbi clearance amount over the past year. And the U.S. has likewise seen a decline from 2.95 percent of all SWIFT renminbi payment settlement, down to 2.51 percent.


Why has the renminbi failed to gain traction?

There are two major reasons for the renminbi’s failure: The occasional extreme volatility of offshore renminbi interest rates, and China’s unpredictable regulatory landscape.

Take a look at the chart below, which shows the overnight Hibor rate for renminbi deposits offshore (i.e., non-mainland China) in Hong Kong. “Hibor” is the Hong Kong Interbank Offered Rate, and represents the interest rate that banks charge one another for lending over a certain period of time. Here we’re looking at the overnight rate.

Over the past year, we’ve seen the overnight rate spike to as high as 60 percent.

These jumps in short-term rates are widely believed to have been engineered by the Chinese authorities as a means of squeezing out anyone looking to “short” (i.e., bet against) the renminbi. When you short a currency, you borrow it and then exchange it into another currency – say, U.S. dollars. (However, you have to pay the interest on the renminbi you borrow.)

With interest rates in the mid- to high- double digits, it becomes extremely expensive to short a currency.

If you look at the chart below showing the renminbi exchange rate against the dollar, you’ll see why the Chinese government purportedly squeezed interest rates so much higher in late 2016 – to protect against currency depreciation. When rates soar, it squeezes out anyone shorting the currency.

The second reason why internationalisation of the renminbi has failed to take off, despite China being the largest exporter in the world (and hence its global commercial ties are huge), is regulatory uncertainty. In other words, you never know quite what the Chinese government is going to do next.

And when you see that kind of volatility in offshore interest rates, along with a generally bearish tone from Western media on the renminbi, as a business dealing with China perhaps you’d rather simply stick with what you know – the dollar, or euro.

Where we go from here

I think that the renminbi will gradually become a more globalised currency. It’s an inevitable part of China’s ongoing integration into the world economy, and the opening of its financial markets. Its economic might demands that eventually the currency becomes more widely used.

But the key word here is gradually. China’s opening up happens in fits and starts, and always with the iron grip of a government that is loathe to tolerate the possibility of loss of control.

We’ve seen a major crackdown for example in offshore investment out of China in the past few weeks.

As we wrote recently:

“This kind of outflow is not sustainable. And what’s more, it’s potentially destabilising for the renminbi currency. Big capital outflows often necessitate selling local currency to buy the acquisition asset currency, typically euros or dollars. This can put excessive downward pressure on the renminbi and complicate efforts by authorities to maintain a stable currency. There’s also a risk that the broader public views such outflows as capital flight, which in turn can exacerbate renminbi selling pressure as others look to join the crocodiles [large China conglomerates] in taking money offshore.”

And it’s likely that as China’s grand development plan,

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