The renminbi has moved closer to joining the other top global currencies in the International Monetary Fund’s Special Drawing Rights (SDR) currency basket after the IMF's managing director Christine Lagarde and her staff gave the green light for the move.
Lagarde said the fund’s staff determined that the Rmb meets the requirements to be a “freely usable” currency and therefore proposes that the executive board include the Chinese currency in the SDR basket.
"I support the staff’s findings,” Lagarde said in a statement on Friday, which was immediately welcomed by the People’s Bank of China (PBoC), the country’s central bank.
The PBoC said the recommendation by Lagarde and its staff reflected China’s economic development and its reforms in the past. ”Beijing will continue to push forward its reform in the country's financial markets and encourage more foreign participants,” it said.
Lagarde will chair a meeting of the IMF’s executive board on November 30 to consider the Rmb’s inclusion in the basket. If the board decides in favour, it would take effect on October 1, 2016, according to a HSBC forecast. The Rmb could have a 14% weight in the SDR, which determines the composition of loans made to countries like Greece.
The IMF reviews the composition of the foreign currencies in the SDR basket every five years and the Rmb’s inclusion would be the first change since 2001, when the euro replaced the German mark and French franc.
Inclusion would make it the fifth currency in the SDR basket after the US dollar, Japanese yen, British pound and Euro, and follows rejection of the Rmb in 2010 because the currency wasn't "freely usable" at that time.
Joining the SDR would be a major milestone for Beijing, which has campaigned hard for the move by issuing Rmb-denominated bonds in overseas markets.
The move could trigger more demand for the Rmb among central banks globally as they should rebalance their foreign exchange holdings relative to the IMF benchmark.
Inclusion in the SDR also illustrates the rise of the world’s second-largest economy and its growing political influence on the world stage.
The Rmb is expected to represent 10% of global reserves by 2025, up from 2.9% by the end of 2015, according to a report by London-based publication Central Banking and HSBC in April, who surveyed 72 central banks responsible for $5.9 trillion in reserves.
Thirty-five central banks, or 53% of respondents, said they were either investing or considering investing in the Chinese currency, although they retained concerns over its convertibility, the liquidity of markets and the quality of credit in some cases, according to the report.
Economists agree that the SDR inclusion would be positive for China and the global economy but China still needs to convince foreign institutions and individual investors of the benefits of holding the Chinese currency.
“While SDR inclusion is an important milestone, it is not the end-game for the internationalization of the Rmb,” said Louis Kuijs, head of Asia Economics at Oxford Economics and a former economist with the IMF between 1997 and 2004.
"It will probably make central banks, sovereign wealth funds and other financial market participants more comfortable to hold Rmb denominated assets, although this will happen gradually." Kuijs added.
In theory, global reserve managers would need to rebalance nearly $1 trillion worth of FX reserves into the Rmb, according to HSBC’s estimate. However, they are unlikely to completely benchmark to the SDR, as they have not done so historically.
The SDR weights are distinctly different from the reserve currency weights indicated by IMF’s Official Foreign Exchange Reserves data, which is closely watched by investors and traders looking for fresh signs of what the global central banks’ actions in the foreign-exchange market.
“If SDR inclusion can bring inflows to China over time, then the PBoC will be more than happy to liberalize some outward flows,” HSBC’s Paul Mackel wrote in a note to client on November 14.