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The open economy

Chinese yuan shrugs off worries in ascent to IMF reserve currency

According to experts, it’s a matter of when, not if the yuan will join the IMF’s Special Drawing Rights

China may have to wait a while longer to find out whether efforts to have the renminbi (RMB) included in the International Monetary Fund’s basket of currencies have paid off.

While the RMB, also known as the yuan, is tightly controlled in China, it’s no secret that the government wants the currency to be more widely used for trade and investment. Chinese regulators have been working with IMF officials to try and qualify to join what’s known as the Special Drawing Rights (SDR) basket, an international reserve that today includes the U.S. dollar, Japanese yen, British pound and the euro.

International currency
What is the SDR?
In 1969, the IMF created a new type of monetary reserve currency for international use named Special Drawing Rights, made up up four major existing currencies. Its intent was to act as an alternative to gold and dollars for settling international accounts.

Reviewed every five years, a decision on the RMB was expected to come later in 2015, but the IMF is now hinting that an outcome might come further down the road.

“A key focus of the current review will be whether the RMB also meets the freely usable criterion in order to be included in the SDR basket,” said Siddharth Tiwari, director of the IMF’s Strategy, Policy, and Review Department last week. The RMB was already previously denied from inclusion in 2010 after it was criticized for not being considered freely convertible.

He said staff are proposing to extend the current SDR basket by nine months until September 30, 2016, to ensure “smooth functioning” of SDR-related operations.

“An extension of nine months would also allow users to adjust to a potential changed basket composition should the Executive Board decide to include the RMB,” he said, noting that the extra time has no impact on the outcome of the review, which he says is still underway.

However, he acknowledged the fact that the RMB is currently the only currency not in the SDR basket that meets the export criterion. IMF managing director Christine Lagarde has also previously said it’s more a question of when, not if, the RMB will be included, especially as the Chinese government continues to push the currency internationally.

Over the past half a decade, China has made a concerted push to establish RMB trading hubs in cities around the world, with one having been launched in Toronto early this year to serve the Americas. It’s a part of China’s move to develop alternative finance channels beyond the U.S. and Europe, having maintained that decreasing dependency on the U.S. dollar would reduce financial risk.

The shift in monetary course is also, “in part out of necessity,” due to the change and slowing of its massive economy, according a new report put together by the Atlantic Council, the City of London Corp, Standard Chartered and Thomson Reuters.

Strategic choices

China’s decision to establish RMB hubs in various cities is the result of careful targeting.

Global Renminbi hubs are the result of strategic choices
Source: Atlantic Council

“As China’s development continues, and as the market for its exports softens due to slower global growth, China’s economy has reached a tipping point, where it is required to transition from an investment- and export-based economy to a consumer-based economy,” the report states.

A more liberalized monetary system will allow China to increase the wealth of its citizens, through an appreciating currency, and boost the role of exports. Among the recommendations, which include reforms in legal infrastructure and transpacific capacity building, is that the RMB be included in the IMF’s basket of currencies.

“Although China is still far away from classically conceived full RMB convertibility and has yet to develop a market-based interest rate instrument, the IMF has recently declared that the currency is no longer undervalued,” the report states. It also notes that the RMB is becoming more available outside of China and used for trade settlement purposes through the country’s current account.

Dr. Chris Brummer, the Atlantic Council’s C. Boyden Gray Fellow on Global Finance and Growth and one of the report’s authors, said China has taken some dramatic steps in recent years to internationalize its currency.

That includes the creation of the Hong Kong-Shanghai Stock Connect program, which allows foreign investors to access Mainland China stocks, and vice versa, alongside other pilot projects that encourage commerce and investment.

“The trend line is pretty obvious that there has been a commitment made to open up the capital account and to facilitate the cross-border flow of capital for investment purposes,” Brummer says.

USD Euro Yen Pound SterlingHe believes the question shouldn’t be whether the RMB should be included in the SDR, but at what weighting compared to the other currencies.

The IMFs metrics are macroeconomic, but Brummer and his report co-authors believe it should be more multidisciplinary, looking at not just how available it is, “but how safe is it to trade and to use and invest in.”

The weighting should also be designed in a way to provide incentives for China to continue its market reform process, Brummer says.

“The more market and regulatory reforms the country makes, the more willing the IMF should be to increase the weighting of the RMB in its currency basket,” he says. “You want to provide positive, as opposed to negative incentives for reform, while at the same time acknowledging the geo strategic and economic importance of China in the global economy.”

“If China’s currency is accepted to the SDR, the inclusion will come with added responsibilities,” says David Craig, president of the Financial and Risk business unit at Thomson Reuters.

“Participants will need to be involved in global regulatory discussions, shaping the future not only of financial regulation but also the rules that govern global commerce,” Craig says.

China will also have to be more transparent and open its books, providing authoritative numbers for its own foreign currency reserves, for instance.

Recent market volatility in China and its slowing economy are also unlikely to weigh on the IMF’s decision, Craig adds.

“The IMF will take a long-term view on whether it should add the renminbi to its basket of currencies,” he says. “Any economy will have periods of growth and stagnation, stability and volatility … What the market is looking for in the longer term is assurance that Chinese regulation is robust and effective. The issue is not whether the renminbi can be volatile, but how China’s regulatory structures can cope with the sort of market stress they have been experiencing recently.”

Learn more

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Download Renminbi Ascending: How China’s currency impacts global markets, foreign policy, and transatlantic regulation

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