BBA607 – ROLE OF INTERNATIONAL FINANCIAL INSTITUTIONS

ans 01
Globalisation
By the term globalization we tend to mean gap from the economy for world market by
attaining international aggressiveness. so the globalization of the economy merely indicates
interaction of the country about production, mercantilism and money transactions with the
developed industrial countries of the globe.
(a) allowing free flow of products by removing or reducing trade barriers between the
countries,
(b) making surroundings for flow of capital between the countries,
(c) permitting free flow in technology transfer and
(d) making surroundings for gratis movement of labour between the countries of the globe. so
taking the whole world as international village, all the four elements are equally necessary for
attaining a sleek path for globalization.
The idea of globalization by integration nation states among the frame work of World Trade
Organisation (WTO) is another version of the ‘Theory of Comparative price Advantage’
propagated by the classical economists for forward unrestricted flow of products between the
countries for mutual profit, particularly from nice kingdom to different less developed
countries or to their colonies.
In this means, the imperialist nations gained a lot of at the price of the colonial countries UN
agency had to suffer from the scar of stagnation and impoverishment. however the advocates
of the policy of globalization argue that globalisation would facilitate the underdeveloped and
developing countries to enhance their competitive strength and attain higher growth rates.
currently it's to be seen however way the developing countries would gain by adopting the
trail of globalization in future.
In the unit of time, numerous countries of the globe have adopted the policy of globalization.
Following a similar path Asian nation had additionally adopted the same policy since 1991
and began the method of disassembly trade barriers along side abolishing quantitative
restrictions (QRs) phase-wise.
Accordingly, the govt of Asian nation has been reducing the height rate of customs in its later
budgets and removed QRs on the remaining 715 things within the EXIM Policy 2001-2002.
of these have resulted open access to new markets and new technology for the country.
the subsequent are a number of the necessary benefits of globalization for a developing
country like India:
(i) globalization helps to spice up the long-standing time average rate of the economy of the
country through:
(a) Improvement within the allocative potency of resources;
(b) Increase in labour productivity; and (c) Reduction in capital-output quantitative relation.
(ii) globalization paves the means for removing unskillfulness in production system.
Prolonged protecting situation within the absence of globalization makes the assembly
system careless concerning price effectiveness which might be earned by following the policy
of globalisation.
(iii) globalization attracts entry of foreign capital along side foreign updated technology that
improves the standard of production.
(iv) globalization sometimes reconstitute production and trade pattern favouring labor-
intensive product and labour-intensive techniques yet as growth of change services.
(v) in an exceedingly globalized situation, domestic industries of developing country become
acutely aware concerning deduction and quality improvement to their merchandise thus on
face foreign competition.
(vi) globalization discourages uneconomical import substitution and favour cheaper imports
of capital product that reduces capital-output quantitative relation in producing industries.
price effectiveness and deduction of factory-made commodities can improve the terms of
change favour of agriculture.
(vii) globalization facilitates commodity industries to expand quicker to satisfy growing
demand for these consumer goods which might result faster growth of employment
opportunities over a amount of your time. this is able to result trickle down impact to scale
back the proportion of population living below the poverty level
(viii) globalization enhances the potency of the banking insurance and money sectors with the
gap up to those areas to foreign capital, foreign banks and insurance corporations.
The following are a number of these disadvantages:
(i) globalization paves the means for distribution of economic power at the globe level
resulting in domination by economically powerful nations over the poor nations.
(ii) globalization sometimes results bigger increase in imports than increase in exports
resulting in growing deficit and balance of payments downside.
(iii) though globalization promote the thought that technological modification and increase in
productivity would result in additional jobs and better wages however throughout the
previous couple of years, such technological changes occurring in some developing countries
have resulted additional loss of jobs than they need created resulting in fall in a job growth
rates.
(iv) globalization has alerted the village and little scale industries and measured death-knell
to that as they can not stand up to the competition arising from well organized MNCs.
(v) globalization has been showing down the method to impoverishment reduction in some
developing and underdeveloped countries of the globe and thereby enhances the matter of
difference.
(vi) globalization is additionally motion as a threat to agriculture in developing and
underdeveloped countries of the globe. like the WTO mercantilism provisions, agricultural
commodities exchange of poor and developing countries are going to be flooded farm
product from countries at a rate a lot of below that autochthonous farm merchandise resulting
in a death-blow to several farmers.
(vii) Implementation of globalization principle changing into tougher in several industrially
developed democratic countries to raise its individuals in reality the pains and uncertainties of
structural adjustment with the hope of obtaining advantages in future.

ans 2
Exchange rates are simply the value at which one currency can be converted to another.
Because this value is constantly changing, the floating exchange rate is always in flux. This
confusing situation can cost anyone who regularly transfers money across currencies.
Exchange rates fluctuate due to a wide range of interrelated factors, but the market reaction to
changes is rarely so straightforward. It’s not as simple as watching the exchange rate and
knowing with certainty that exchange rates will rise or fall when certain levers are pulled.
Instead, exchange rates move due to a mix of art and science, hyper logical data-driven
analysis, and the quirks of human psychology.
It’s not possible to accurately predict what will happen to an exchange value, and when; if it
was, we would all be Forex millionaires. But if you regularly transfer your cash between
currencies, you might be interested in the mechanics at work behind the exchange rate.
Here’s a beginner’s guide to the factors that influence changes in exchange rates.
1. Exchange rates are affected by supply and demand
Supply and demand is the most basic factor affecting exchange rates. It’s relatively easy to
understand, but not always easy to predict. In simple terms, when there's an excessive supply
of something the value attached to it decreases, while an increase in demand raises value.
The factors detailed below can impact supply and demand of currency, and cause the
exchange rate to fluctuate. However, more deliberate factors may also be at play. For
example, governments might intervene in the currency markets to cause their national
currency to rise or fall in value. If they're concerned with exporting more products, then it
makes sense to lower the value of the local currency to make themselves more competitive.
This can be achieved by buying up foreign currencies to increase their value, and lower the
local currency by comparison.
On the other hand, speculation by investors, individuals and funds, can cause changes in an
exchange rate; especially if there’s momentum which triggers a run on a currency. For
example, if investors agree that a particular country has a shaky economy, they might believe
that the currency value will drop in the future, and withdraw their investments before it does
so. As they sell their currency, the supply on the open market increases, causing the value to
drop further. As this happens, more investors are alerted to the fall in price and scramble to
sell too, resulting in a shift in the exchange rates on offer.
2. Exchange rates are affected by interest and inflation rates
Inflation is the rate at which goods and services rise in cost over time; while interest rates
reflect the charges made by banks for individuals to borrow money (or, conversely, the
earnings accrued on savings). National bodies, such as the UK’s Bank of England or the
Federal Reserve in the US, manage national interest rate targets to balance inflation and keep
the economy growing. The two are naturally linked because lower interest rates tend to lead
to more people borrowing money, increasing spending and ultimately pushing up costs.
Increased interest rates can reduce spending, keeping costs low but ultimately risking
economic stagnation.

3. Exchange rates are affected by balance of trade deficits

Think of this as the nation’s bank account. The balance of trade describes the difference in
value between the goods and services one country buys from abroad, versus the value of
goods and services the country sells to others. If the nation is buying more than it’s selling,
then the balance of trade is in deficit. If more is exported than imported, the country has a
balance of trade surplus.
This matters to exchange rates. If a country buys in more than it sells, it needs more foreign
capital than it's receiving through exporting local goods. This creates a demand for foreign
currencies which can increase their value on the open market. On the other hand, there’s
likely to be an excess of local currency which isn't being used because more is being spent
abroad. This excess supply drives down the value of the local currency, meaning that when
there is a balance of trade deficit, the local currency is likely to lose value against foreign
currencies.
4. Exchange rates are affected by government debt
Just as individuals have credit histories, so do nations. Ratings agencies such as Moody’s and
Standard & Poor’s, give whole countries a credit rating based on their likelihood of
defaulting on any public debts they might have - and this can have a bearing on the exchange
rate.
Because major infrastructure projects and other public sector initiatives can be a great way to
stimulate economic growth, governments are fond of embarking on them when times are
tough. Naturally this requires investment, which might have to be borrowed - creating public
debt. This can worry foreign investors, who are concerned about the possibility of default or
the rising inflation that sometimes accompanies large public debts. The end result is
something of a game of chicken - some public debt might stimulate economic growth and be
a real draw to global investors. Too much debt and the opposite might happen. If foreign
investors are wary of investing in the local currency, there will be an over supply and the
exchange rate will fall.
5. Exchange rates are affected by political and economic stability
This may be the most complex factor of all. There’s nothing the markets like less than
instability. Investors, faced with the prospect of change in the political or economic situation
in a country, might be tempted to cash in their assets and move them to a more stable
environment. This can cause the exchange rate to crash.
The complexity here comes from the fact that the whole global economy and political
landscape is interwoven - now more than ever. So decreasing growth in the Far East has a
huge knock on impact in the global economy. The prospect of political change in the US, or
changes to the shape of the European Union, can cause an upheaval in the markets around the
world.
It's almost impossible to predict precisely how investors and businesses will react to the
multitude of changes that happen around them. While some fluctuations are predictable,
others aren't. Rapid political change can cause seismic and unpredictable shifts - such as the
nationalisation of industry seen in Venezuela under Chavez. Other unexpected events like
wars and terrorist attacks can equally cause volatility in the exchange rates as investors seek
the safest places for their money.
The bottom line
Changing exchange rates can be a headache if you travel frequently, send money home, or
draw earnings in a currency that's different to your local one. Watching the markets change
can give some indication as to the best time to make transfers, but it’s not foolproof - even
professional Forex traders get it wrong.
If you’re trading relatively small amounts of currency, opaque rates, high charges and
complex platforms are your biggest enemies. Watch the market by all means, but leave the
bets to the pros, and instead look for the best deals available when you want to switch
currencies.
When exchanging your money consider using TransferWise, for low and transparent fees.
With Transferwise, you can transfer money between bank accounts using the real mid-market
exchange rate. It's a quick and convenient way to get your cash, with no hidden fees.
ans 3
Letters Of Credit – Definition, Types & Process
Updated on May 29, 2019 - 05:56:00 PM
A letter of credit is a document that guarantees the buyer’s payment to the sellers. It is Issued
by a bank and ensures the timely and full payment to the seller. If the buyer is unable to make
such a payment, the bank covers the full or the remaining amount on behalf of the buyer. A
letter of credit is issued against a pledge of securities or cash. Banks typically collect a fee, ie,
a percentage of the size/amount of the letter of credit.
Importance of letters of credit

 Parties to a letter of credit

 Types of a letter of credit
 Sight Credit
 Acceptance Credit/ Time Credit
 Revocable and Irrevocable Credit
 Confirmed Credit
 Importance of letters of credit
Since the nature of international trade includes factors such as distance, different laws in each
country and the lack of personal contact during international trade, letters of credit make a
reliable payment mechanism. The International Chamber of Commerce Uniform Customs
and Practice for Documentary Credits oversees letters of credit used in international
transactions
Parties to a letter of credit
Applicant (importer) requests the bank to issue the LC
Issuing bank (importer’s bank which issues the LC [also known as the Opening banker of
LC])
Beneficiary (exporter)
Types of a letter of credit
The letters of credit can be divided into the following categories:

Sight Credit
Under this LC, documents are payable at the sight/ upon presentation of the correct
documentation.
For example, a businessman can present a bill of exchange to a lender along with a sight
letter of credit and take the necessary funds right away. A sight letter of credit is more
immediate than other forms of letters of credit.
Acceptance Credit/ Time Credit
The Bills of Exchange which are drawn and payable after a period, are called usance bills.
Under acceptance credit, these usance bills are accepted upon presentation and eventually
honoured on their respective due dates. For example, a company purchases materials from a
supplier and receives the goods on the same day. The bill will be delivered with the shipment
of goods, but the company may have up to 30 days to pay it. This 30 day period marks the
usance for the sale.

Revocable and Irrevocable Credit

A revocable LC is a credit, the terms and conditions of which can be amended/ cancelled by
the Issuing Bank. This cancellation can be done without prior notice to the beneficiaries.
An irrevocable credit is a credit, the terms and conditions of which can neither be amended
nor cancelled. Hence, the opening bank is bound by the commitments given in the LC.
Confirmed Credit
Only Irrevocable LC can be confirmed. A confirmed LC is one when a banker other than the
Issuing bank, adds its own confirmation to the credit. In case of confirmed LCs, the
beneficiary’s bank would submit the documents to the confirming banker.
Transferable Credit
While an LC is not a negotiable instrument, the Bills of Exchange drawn under it are
negotiable. A Transferable Credit is one in which a beneficiary can transfer his rights to third
parties. Such LC should clearly indicate that it is a ‘Transferable’ LC
SET II
ANS 01
WORLD BANK
It helps the war-devasted countries by granting them loans for reconstruction. Thus, they
provide extensive experience and the financial resources of the bank help the poor countries
increase their economic growth, reducing poverty and a better standard of living.
i. To assist in the construction and development of the territories of its members by
facilitating the investment of capital for productive purposes, including the ‘restoration of
economies destroyed or disrupted by war’, and the encouragement of the ‘development’ of
productive facilities and resources in less developed countries.
ii. To promote private investment and long run balanced growth of international trade and
BOP equilibrium by means of guarantees or participations in international loans and
investments.
iii. To arrange loans made or guaranteed by it, so that more useful and urgent projects receive
preference.
iv. To provide finance to projects from its own capital, funds raised by it and by participating
with other members.
Objectives of the World Bank:
The purposes and objectives are constantly changing. For instance, the WB decided to put
emphasis on the alleviation of poverty in less developed countries in the late 1960s and
1970s. It also introduced structural adjustment programmes (SAPs) in developing countries
so that not only macroeconomic stability can be attained but also structural reforms aimed at
accelerating growth can be undertaken.

ANS 2
BASEL III
Basel III Norms in India: Meaning, Requirement and Impacts on Indian Banking system
Basel III or Basel 3 released in December, 2010 is the third in the series of Basel Accords.
These accords deal with risk management aspects for the banking sector. These Norms to be
partially implemented from March 31, 2015 in phases and would be fully implemented as on
March 31, 2018.
Basel III or Basel 3 released in December, 2010 is the third in the series of Basel Accords.
These accords deal with risk management aspects for the banking sector. So we can say that
Basel III is the global regulatory standard on bank capital adequacy, stress testing and market
liquidity risk. (Basel I and Basel II are the earlier versions of the same, and were less
stringent). Norms to be implemented from March 31, 2015 in phases and would be fully
implemented as on March 31, 2018
According to Basel Committee on Banking Supervision "Basel III is a comprehensive set of
reform measures, developed by the Basel Committee on Banking Supervision, to strengthen
the regulation, supervision and risk management of the banking sector".
Thus, we can say that Basel III is only a continuation of effort initiated by the Basel
Committee on Banking Supervision to improve the banking regulatory framework under
Basel I and Basel II. This latest Accord now seeks to improve the banking sector's ability to
deal with financial and economic stress, improve risk management and strengthen the banks'
transparency.
Basel 3 measures aim to:
Improve the banking sector's ability to absorb ups and downs arising from financial and
economic instability
Improve risk management ability and governance of banking sector
Strengthen banks' transparency and disclosures
Thus we can say that Basel III guidelines are targeted at to improve the ability of banks to
withstand periods of economic and financial stress as the new guidelines are more stringent
than the earlier requirements for capital and liquidity in the banking sector.
Better Capital Quality: One of the key elements of Basel 3 is the introduction of much stricter
definition of capital. Better quality capital means the higher loss-absorbing capacity. This in
turn will mean that banks will be stronger, allowing them to better withstand periods of
stress.
Capital Conservation Buffer: Another key feature of Basel iii is that now banks will be
required to hold a capital conservation buffer of 2.5%. The aim of asking to build
conservation buffer is to ensure that banks maintain a cushion of capital that can be used to
absorb losses during periods of financial and economic stress.
Countercyclical Buffer: This is also one of the key elements of Basel III. The countercyclical
buffer has been introduced with the objective to increase capital requirements in good times
and decrease the same in bad times. The buffer will slow banking activity when it overheats
and will encourage lending when times are tough i.e. in bad times. The buffer will range from
0% to 2.5%, consisting of common equity or other fully loss-absorbing capital.
Leverage Ratio: A review of the financial crisis of 2008 has indicted that the value of many
assets fell quicker than assumed from historical experience. Thus, now Basel III rules
include a leverage ratio to serve as a safety net. A leverage ratio is the relative amount of
capital to total assets (not risk-weighted). This aims to put a cap on swelling of leverage in
the banking sector on a global basis. 3% leverage ratio of Tier 1 will be tested before a
mandatory leverage ratio is introduced in January 2018.
Liquidity Ratios: Under Basel III, a framework for liquidity risk management will be created.
A new Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) are to be
introduced in 2015 and 2018, respectively.
Systemically Important Financial Institutions (SIFI): As part of the macro-prudential
framework, systemically important banks will be expected to have loss-absorbing capability
beyond the Basel III requirements. Options for implementation include capital surcharges,
contingent capital and bail-in-debt
The Basel III which is to be implemented by banks in India as per the guidelines issued by
RBI from time to time will be challenging task not only for the banks but also for
Government of India. It is estimated that Indian banks will be required to raise Rs 6, 00,000
crores in external capital in next nine years or so i.e. by 2020 (The estimates vary from
organisation to organisation). Expansion of capital to this extent will affect the returns on the
equity of these banks especially public sector banks. However, only consolation for Indian
banks is the fact that historically they have maintained their core and overall capital well in
excess of the regulatory minimum.

 Basel III builds on the three pillars from Basel II. Focus is on
 enhancing the quality and quantity of the capital and to have
 stronger risk coverage. The highlights of Basel III are as
follows:
Implements changes starting Jan 2013 and going through a transitional period that lasts
until Jan 2019
Raises the quality, consistency, and transparency of the capital base through stricter rules
on eligibility of instruments to be included in (core) Tier 1 capital.
Enhance risk coverage by strengthening counterparty credit risk capital requirements
arising from derivatives, repurchase transactions, and security financing.
Supplements risk-based capital requirements with the addition of a non-risk-based leverage
ratio as a backup measure.
Reduce procyclicality and promotes countercyclical capital buffers through a combination
of forward looking provisioning and capital buffers.

ans 3
Explain The Euro Zone Debt Crisis and China’s Yuan Revolution.

The eurozone debt crisis was the world's greatest threat in 2011. That's according to the
Organization for Economic Cooperation and Development. Things only got worse in 2012.
The crisis started in 2009 when the world first realized Greece could default on its debt. In
three years, it escalated into the potential for sovereign debt defaults from Portugal, Italy,
Ireland, and Spain. The European Union, led by Germany and France, struggled to support
these members. They initiated bailouts from the European Central Bank and the International
Monetary Fund.
These measures didn't keep many from questioning the viability of the euro itself.
A new crisis might be brewing. On August 10, 2018, President Trump announced he would
double the tariffs on aluminum and steel imports from Turkey. He was trying to obtain the
release of jailed American pastor Andrew Brunson. Turkey claims he was involved in the
2016 coup to overthrow the government. The U.S. move lowered the value of the Turkish lira
to a record low against the U.S. dollar.
It renewed fears that the poor health of the Turkish economy could trigger another crisis in
the eurozone. Many European banks own stakes in Turkish lenders or made loans to Turkish
companies. As the lira plummets, it becomes less likely these borrowers can afford to pay
back these loans. The defaults could severely impact the European economy. As a result,
Germany is considering lending Turkey enough to prevent a crisis.
How the Eurozone Crisis Affected You
If those countries had defaulted, it would have been worse than the 2008 financial crisis.
Banks, the primary holders of sovereign debt, would face huge losses. Smaller banks would
have collapsed. In a panic, they'd cut back on lending to each other. The Libor rate would
skyrocket like it did in 2008.

The ECB held a lot of sovereign debt. Default would have jeopardized its future. It threatened
the survival of the EU itself. Uncontrolled sovereign debt defaults could create a recession or
even a global depression.
It could have been worse than the 1998 sovereign debt crisis. When Russia defaulted, other
emerging market countries did too. The IMF stepped in. It was backed by the power of
European countries and the United States. This time, it's not the emerging markets but the
developed markets that are in danger of default. Germany, France, and the United States, the
major backers of the IMF, are themselves highly indebted. There would be little political
appetite to add to that debt to fund the massive bailouts needed.
What Was the Solution?
In May 2012, German Chancellor Angela Merkel developed a seven-point plan. It went
against newly-elected French President Francois Hollande's proposal to create Eurobonds. He
also wanted to cut back on austerity measures and create more economic stimulus. Merkel's
plan would:
The seven-point plant followed an intergovernmental treaty approved on December 8, 2011.
The EU leaders agreed to create a fiscal unity parallel to the monetary union that already
exists. The treaty did three things. First, it enforced the budget restrictions of the Maastricht
Treaty. Second, it reassured lenders that the EU would stand behind its members' sovereign
debt. Third, it allowed the EU to act as a more integrated unit. Specifically, the treaty would
create five changes:
Eurozone member countries would legally give some budgetary power to centralized EU
control.
Members that exceeded the 3 percent deficit-to-GDP ratio would face financial sanctions.
Any plans to issue sovereign debt must be reported in advance.
The European Financial Stability Facility was replaced by a permanent bailout fund. The
European Stability Mechanism became effective in July 2012. The permanent fund assured
lenders that the EU would stand behind its members. That lowered the risk of default.
Voting rules in the ESM would allow emergency decisions to be passed with an 85 percent
qualified majority. This allows the EU to act more quickly.
Eurozone countries would lend another 200 billion euros to the IMF from their central banks.
This followed a bailout in May 2010. EU leaders pledged 720 billion euros or $928 billion to
prevent the debt crisis from triggering another Wall Street flash crash. The bailout restored
faith in the euro which slid to a 14-month low against the dollar.
The United States and China intervened after the ECB said it would not rescue Greece. Libor
rose as banks started to panic just like in 2008. Only this time, banks were avoiding each
other’s toxic Greek debt instead of mortgage-backed securities.
First, the United Kingdom and several other EU countries that aren't part of the eurozone
balked at Merkel's treaty. They worried the treaty would lead to a "two-tier" EU. Eurozone
countries could create preferential treaties for their members only. They would exclude EU
countries that don't have the euro.
Second, eurozone countries must agree to cutbacks in spending. This could slow their
economic growth, as it has in Greece. These austerity measures have been politically
unpopular. Voters could bring in new leaders who might leave the eurozone or the EU itself.
Causes
First, there were no penalties for countries that violated the debt-to-GDP ratios. These ratios
were set by the EU's founding Maastricht Criteria. Why not? France and Germany also were
spending above the limit. They'd be hypocritical to sanction others until they got their own
houses in order. There were no teeth in any sanctions except expulsion from the eurozone, a
harsh penalty which would weaken the power of the euro itself. The EU wanted to strengthen
the euro's power. That put pressure on EU members, not in the eurozone.
Second, eurozone countries benefited from the euro's power. They enjoyed the low-interest
rates and increased investment capital. Most of this flow of capital was from Germany and
France to the southern nations. This increased liquidity raised wages and prices. That made
their exports less competitive. Countries using the euro couldn't do what most countries do to
cool inflation. They couldn't raise interest rates or print less currency. During the recession,
tax revenues fell. At the same time, public spending rose to pay for unemployment and other
benefits.
Third, austerity measures slowed economic growth by being too restrictive. For example, the
OECD said austerity measures would make Greece more competitive. It needed to improve
its public finance management and reporting. It was healthy to increase cutbacks on public
employee pensions and wages. It was a good economic practice to lower its trade barriers. As
a result, exports rose. The OECD said Greece needed to crack down on tax dodgers. It
recommended the sale of state-owned businesses to raise funds.
In return for austerity measures, Greece's debt was cut in half. But these measures also
slowed the Greek economy. They increased unemployment, cut back consumer spending, and
reduced capital needed for lending. Greek voters were fed up with the recession. They shut
down the Greek government by giving an equal number of votes to the "no austerity" Syriza
party. Another election was held June 17 that narrowly defeated Syriza. Rather than leave the
eurozone though, the new government worked to continue with austerity.

china yuan revolution

Once you think of China as a teenager in her “awkward stage,” it may become easier to
understand the unfolding dynamics. When it comes to foreign exchange, China’s latest move
may be best explained by her desire to play with the grown-ups. This may have implications
that go far beyond the U.S. dollar and China’s Yuan (“CNY” or also the Renminbi or
“RMB”).
On August 11, 2015, the People’s Bank of China (PBoC), set the CNY fixing nearly 1.9%
lower versus the U.S. dollar compared to the previous day;1 during the subsequent days, the
currency fell further, but – as of this writing – has stabilized. Resulting headlines included:
“China Fires the First Shot in a Currency War” (WSJ 8/13/2015)
We all like a little drama, but let’s first debunk these headlines before focusing on what’s
happening:
China is clearly not the first if indeed this were a shot in the currency wars. The U.S. was the
first major country to pursue quantitative easing, or “QE”, the ultra-loose monetary policy
that paved the way for Japan and the Eurozone, to name just the two biggest ones, to follow
suit.
If China were really breaking this line of “global economic defense”, we would see a 20% or
more deduction. Keep in mind that in our analysis, China’s currency has substantially
appreciated on a trade weighted basis versus its peers and the drop we have seen is unlikely
to have a major impact on China’s economy in the short-term.
Barron’s relates China’s move to President Richard Nixon’s August 15, 1971 “temporarily”
abandoning what was left of the gold standard (Barron’s 8/17/2015). As far as significance is
concerned, we tend to agree that it may be as relevant. But Nixon’s move was one of
throwing in the towel after much gold had left U.S. vaults. China, in contrast, holds about
$1.5 trillion in Treasuries (“about” because two hundred billion are held via custodial
accounts in Belgium and other places that may or may not all be publicly disclosed) and
while there have been times this year when China has sold Treasuries, we see no sign of
desperation; details of major foreign holders of Treasury Securities are available at
Treasury.gov.
The reason why the Nixon comparison is valid nonetheless is because it may well also be
historically just as significant. China has been courting the International Monetary Fund
(IMF) to have the yuan be included in the IMF’s Special Drawing Rights, the SDRs. SDRs
are a claim on a basket of currencies comprised of the U.S dollar at 41.9%; the euro at 37.4%;
the British pound at 11.3%; and the Japanese yen at 9.4%. In July, Greece, for example, paid
back (with delay) the IMF SDR 1.16 billion in loans worth about €2 billion or $2.2 billion.
As such, the IMF’s SDR are considered an international reserve currency that member
countries can tap into.
Conversely, should the RMB be included in the IMF’s reserve currency, there is an
expectation that central bank managers that use SDRs in their reserve currency management
will add CNY. While most central banks manage their currency reserves according to their
particular needs and not specifically SDRs, an inclusion in the SDR basket may show the
world that China’s currency is ready for prime time, i.e. that it plays in the same league as the
U.S. dollar, euro, the British pound, and the Japanese yen.