Tuesday, November 17, 2015

RMB inclusion in SDR: near-term increase in capital inflows unlikely - Nomura

FXStreet (Bali) - Asia FX Strategist at Nomura note that despite the IMF staff proposal to include the Chinese Yuan - RMB - in its Special Drawing Rights (SDR) basket, a rapid near-term increase in capital inflows is unlikely in their view.

Key Quotes

IMF Managing Director Christine Lagarde issued a statement late Friday that the IMF staff had proposed that the Executive Board include RMB in its Special Drawing Rights (SDR) basket. She supported the findings and will chair a meeting of the Board to consider the issue on 30 November.

This suggests that Executive Board approval, should it be forthcoming, is likely to be unconditional. Separately, in a teleconference with China’s Vice-Premier Wang Yang, US Treasury Secretary Jack Lew said the US would support RMB inclusion if it meets the IMF’s existing criteria. With similar support previously expressed by various IMF members, it is now most likely that RMB will be included in the SDR basket, which was already the consensus view prior to the IMF’s Friday statement.

In this scenario, a rapid near-term increase in capital inflows is unlikely in our view, although gradual capital inflows should be the theme over the longer term, as global FX reserves reallocation takes place. The immediate and direct benefits from capital inflows because of SDR basket inclusion are likely to be limited as any transactions would be done between central banks and not through the open market.

Furthermore, the size of the SDR is relatively small, at around USD280bn (equivalent as of 10 September 2015) and if China attains a 10-15% weighting, this would imply a reallocation to RMB of only USD28-42bn. Further, upon approval, RMB’s inclusion would not be effective until after 30 September 2016.

We also believe that reserve managers and sovereign wealth funds may exercise a certain amount of caution before investing in RMB assets because of concerns over China's economy and financial market valuations stemming from the Chinese government's multi-market intervention.

After SDR inclusion, we believe it is likely that the People’s Bank of China (PBoC) could gradually step away from FX intervention to allow for a more market-determined exchange rate. In the unlikely event that the IMF denies RMB entry into the SDR basket, there is some concern that Chinese authorities may change their current stance in keeping USD/RMB stable.

In the run up to the 30 November meeting, the risk is that the PBoC attempts to converge the onshore and offshore FX rates again – the central bank has in the past highlighted “the formation of a single exchange rate in both onshore and offshore markets” to facilitate RMB inclusion in the SDR.

With the spread between spot offshore USD/CNH and onshore USD/CNY widened to around 400 pips last Friday (250 pips currently), we had recommended a short 3w USD/CNH against long 3w USD/CNY to position for convergence in the two rates, ahead of the Executive Board meeting at the end of November
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