Why China Isn't a Financial Center
Amid all the buzz about China's hosting the G-20 summit in Hangzhou -- all the accords, arguments and alleged snubs -- another symbolically significant event was largely obscured. Last week, the World Bank issued bonds denominated in Special Drawing Rights, or SDRs, in China's interbank market. Beginning in October, the yuan will be included in the basket of currencies used to set the SDRs' value.
To China, this symbolizes its status as a rising power. I'd argue that it instead symbolizes why China is struggling to become a global financial center.
Beijing conceived of SDRs as something of a compromise. It would like the global monetary system to be less reliant on the U.S. dollar and more favorable toward its own currency. Yet it continues to impose capital controls, which limit the yuan's usage overseas, and it doesn't want to let the yuan's value float freely, which would be a prerequisite to its becoming a true reserve currency.
China saw SDRs as a way to split the difference, to create a competitor to the dollar and maintain a fixed exchange rate at the same time.
The problem is that there's almost no conceivable reason to use them. SDRs were created as a synthetic reserve asset by the International Monetary Fund decades ago, under the Bretton Woods system. No country uses them for normal business, and no government is likely to issue bonds denominated in them except for political reasons, as the World Bank is doing.
Companies won't use them either. If a firm wants to borrow to build a plant in Japan, it will issue a bond in yen so it can repay in yen. If its customers are global, surely an ambitious investment bank would be willing to build a customized currency portfolio index that would match its needs. Rather than using the SDR's weighting of currencies, the company could sell a bond in a synthetic index of anything: a 25 percent split between dollars, euros, yen and reals, say. No customer pays in SDRs; why bind yourself to repaying debts in them?
The reason China is pushing SDRs is that it hopes to gain the prestige of a global currency without facing the financial pressure to let the yuan float freely or to loosen capital controls. It wants the benefits of global leadership, in other words, but would prefer to avoid the drawbacks.
This is precisely the attitude that's hindering China's rise as a global financial center. It has all the right ingredients to compete with London and New York: a vast economy, an international business focus and top-flight bankers who create innovative products. Global demand for Chinese capital and financial services is on the rise.
Yet China's international debt and equity issuance is almost non-existent. Of the nearly 2,000 bond issues in China so far this year, only one has been international. Companies don't want to sell debt or shares in a country with tightly controlled capital flows and a currency that doesn't reflect the market. As with SDRs, the government can't have it both ways.
If Beijing wants to become a center of global finance, it needs a market in which capital flows freely, prices fluctuate with demand and the rules are transparent. Rather than pursuing symbolic victories like SDR bonds, China should be letting its bankers and capital go forth.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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