IMF adds Renminbi to Special Drawing Rights (SDR) basket
While most people are content with celebrating the week-long National Holiday, October 1 also marks an important date to China’s Renminbi (RMB), as it has officially joined the International Monetary Fund’s (IMF) Special Drawing Rights (SDRs).
Effective October 1, 2016, the RMB was approved by the board of the IMF in November of last year, making the Chinese Yuan the fifth currency that is included, along with the US Dollar, the Euro, the Japanese Yen, and the British Pound. According to IMF, the weights of each currency would be 41.73 percent for the U.S. Dollar, 30.93 percent for the Euro, 10.92 percent for the Chinese Yuan, 8.33 percent for the Japanese Yen, and 8.09 percent for the Pound Sterling.
RMB becoming the world go-to currency?
It’s no secret that China has long desired to provide the international community an alternative to the US Dollar, and its plans to do so just received a boost. On paper, the SDRs value outstanding is not very significant, as based on IMF, by March 2016, there were 204.1 billion SDRs (equivalent to USD 285 billion) allocated to IMF members, compared with about USD 11 trillion of global reserves.
However, the RMB’s inclusion is a recognition of China’s importance in the global economy and the reforms done to make its currency more freely traded. Through the process of internationalisation, RMB inclusion will also help China strengthen its economy by developing a more transparent and liquid financial market, and achieving a certain degree of openness of the capital accounts. Given China’s economic scale and business footprints in the global market, it is highly predictable that in the future, the RMB would be comprehensively used in international finance and trades, indicating a gradual expansion of the Yuan circulation.
Opening up could mean short-term pain, long-term gain
In the past, the RMB has enjoyed limited popularity in the international trade community as strict capital controls limited dealing in the foreign exchange markets. When China made its first bid for SDR inclusion in 2010, according to the Bank for International Settlements, the Yuan’s share of global currency trading was a mere 0.3 percent of total, making it no more significant than the Malaysian Ringgit.
Now that the RMB is in the league, China would have to relax its controls and free up cross-border flows of capital, and move away from the old state-directed system. The problem with relaxation is China’s concerns on the stability of its domestic financial system, and the volatility that would result from opening up. While fixed exchange rates and capital controls may have worked well during China’s early stages of export-led growth, relaxation is the key to China’s next stage of consumption-driven development.
According to Bloomberg, the yuan’s inclusion in the SDR will prompt central banks and fund managers to buy more Chinese assets, with estimates of as much as USD 1 trillion of inflows in the next five years. With more foreign direct investment from an opened market, this would benefit the financial sector among others, and likely lead to an increase in demand for office space in China.