RMB as a reserve currency? Miles to go....

Miles to go before I sleep mused Robert Frost. The question of the RMB as a reserve currency merits the same quote.

The Chinese having floating this idea rather enthusiastically of late and have even initated yuan settled trades in HK and Russia's Putin has echoed this sentiment and called for Yuan to be traded in Russia and used in trade settlements. While some of the RMB's rise especially as a regional currency is indeed warranted, the more grandiose dreams of replacing the greenback are bit farfetched. A reuters' video should illustrate how the tip of the iceberg looks like.

http://jp.reuters.com/news/video?videoId=169173082&videoChannel=204

First, it would be interesting to see why the USD is the reserve currency of the world (before that the sterling), there are 3 reasons

a. availability
b. liquidity
c. perceived safety

Each of the above factors are very important. The USD for starters is widely available and is backed with deep and liquid capital markets. While the historic circumstances circa 1945 are resented in some parts of the oriental world, the fact remains the US has the best functioning capital markets in the world despite the 2008-09 crisis.

Availability has another dimension, openness of an economy. The US is arguably one of the most open economies in the world. The US for instance exported capital till 1971 when it reversed course and ran deficits. essentially BoP ensured the greenback's availability. The RMB is so behind in this department with basic financial clearing infrastructure still deficient severely.

Currently, getting money in (easy) and out (pain in the nether regions) of the PRC is overall a pain. For a concrete example, Look at the figure above to see that debt capital markets which are a basic barometer of market depth is very indicative of China's illquidity and ill-preparedness for any big role even on a APAC scale.

Growth Engine: The last aspect directly links to export dependence and investment driven nature of the Chinese economy. While exports are plateauing out, China is heavily dependent on internal investments for growth. Consumption as a % of GDP is around 37-40% (see picture), way less than even say India or the US. Chinese restrictions on capital ensure a BoP surplus on both accounts. This ensures the RMB can never be held in large amounts outside PRC.

All this has missed one elephant in the room: The PRC's brand of politics internationally has started ignoring Deng Xiaoping's advice to bide time and be prudent. Abrasiveness is becoming visible and I am afraid the PRC does not have the fire power yet to ride roughshod....this should in addition to the dangers mentioned above should ensure preponderance of the USD with the RMB growing in stature to an important baslet currency in the FEER/REER sense..

Note: McKinsey, Reuters and Tiburon Partners are acknolwledged for data