Chinese central bank governor Zhou Xiaochuan recently gave an interview to Caijing magazine, on the occasion of the first anniversary of the renminbi’s inclusion in the currency basket for the IMF’s Special Drawing Right, or SDR, alongside the dollar, euro, pound and yen. This obscure piece of financial infrastructure improbably dominated the headlines for a while, as China waged a public campaign for inclusion. But most people could not figure out why SDR inclusion meant so much to China, and in the end the world seemed to decide that it was mostly a symbolic victory in China’s quest for global status. We haven’t heard much about the SDR since.
Zhou, though, still seems to think that SDR inclusion was a big deal. And since he has for decades been one of the main figures driving the modernization of China’s financial system, his track record is not that of someone who just pursues empty pieces of symbolism. Zhou is already past the normal retirement age and probably will not be in office this time next year, so SDR inclusion is part of his legacy. In the long interview (Chinese text here), he gives what I think is quite a revealing justification:
The entry of the renminbi into the SDR basket will produce a “ratcheting effect” for China’s opening up. This is like the ratchet on the rope in a volleyball net; when the net is tightened the ratchet latches on to the rope, so once it is set in position it cannot go back, cannot reverse. In English there is an expression, “past the point of no return.” Of course, in economics and society there is no absolute “ratchet,” I don’t mean that it’s absolutely impossible for there to be a reverse, just that it is very difficult.
In China’s reform and opening up process, whether in attracting foreign investment, liberalizing foreign trade, reforming the exchange rate, entering the WTO, etc, there were often some small reversals in the middle, or kind of a stop-and-go. But once we took that step, it was very difficult to go back.
After the renminbi entered the SDR, both international institutions and financial markets are using the renminbi more and more; international investors are using the renminbi to invest in the domestic financial market; laws and regulations have been revised; traders and exporters are all using new procedures. If you want to go backward, it is difficult, and the costs are high.
Perhaps another way of putting this is that SDR inclusion is a commitment device. In addition to the practical concerns raised by Zhou, there would also be reputational costs to reversing exchange-rate and capital-account reforms. Since SDR inclusion is contingent on the IMF’s determination that the renminbi is “freely usable,” it could conceivably be reversed if the currency were to stop being freely usable. What future Chinese central bank governor will want to see headlines screaming “IMF expels renminbi from SDR”?
Of course, China over the past year has in fact been de-facto tightening capital controls by stepping up scrutiny of overseas M&A and slowing down approval of foreign-exchange transactions. But it has done so largely by using its regulatory discretion rather than changing formal rules. So perhaps the commitment device is working some.
It is telling though that this justification for SDR inclusion is about consolidating and defending past reforms, rather than advancing new ones, though Zhou clearly wants to see those as well.