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YUAN ENTERS THE ELITE CURRENCY CLUB China knocks on the reserve-currency door

Yuan Enters the Elite Currency Club

On 30th November 2015, the Executive Board of the IMF announced that it had completed the regular five-yearly review of the basket of currencies making up the Special Drawing Rights (SDR) and had admitted China’s yuan or renminbi (RMB) to the elite club of currencies. As such, RMB was determined to be a freely usable currency, along with the US dollar, euro, Japanese yen and British pound. Launching the new SDR basket with effect from October 1, 2016 would provide sufficient lead time for the IMF, its members and other SDR users to adjust to this change.

The Managing Director of the IMF, Christine Lagarde termed the inclusion of yuan in IMF currency basket as “an important milestone in the integration of the Chinese economy into the global financial system”. It was also a recognition of the progress that the Chinese authorities had made in the past years in reforming Chinese monetary and financial system. It is being said that the continuation and deepening of these efforts would bring about a more robust international monetary and financial system, which, in turn, will support the growth and stability of China and the global economy. The inclusion of RMB would also enhance the attractiveness of the SDR by diversifying the basket and making it more representative of the world’s major currencies. Authorities of all currencies represented in the SDR basket, which now also include Chinese authorities, are expected to maintain a policy framework that would facilitate operations for the IMF, its membership and other SDR users in their currencies.

Yuan Enters the Elite Currency Club 1The inclusion of RMB in the SDR basket is, of course, a major development and shows the degree of responsiveness of the multilateral financial institutions to the changes in economic strength of their member countries. So far as China remained underdeveloped, its currency or for that matter its other features or characteristics were not seriously taken into account for policy purposes on a global scale. However, in the last two decades or so, China has developed so rapidly that its national income has surpassed all expectations and it is now ranked as world’s second-largest economy. In particular, its exports, foreign exchange reserves, foreign investment and innovative skills have overawed other countries to the extent that they are obliged to watch its policies and performance minutely to adjust their policies to the Chinese conduct. The IMF’s decision to admit China’s yuan into its benchmark currency basket (SDR) is, therefore, a kind of victory for Beijing’s efforts towards recognition as a global economic power, enabling the RMB to be included in the elite currencies of the world. However, it may be added that SDR is not a freely traded currency but an important reserve asset in which the IMF issues its loans under various facilities.

Yuan Enters the Elite Currency Club 2So far as the weight of China’s yuan in the SDR basket of currencies is concerned, it may be mentioned that basket composition is reviewed every five years. At the last rebalancing in 2010, the US dollar accounted for 41.9 percent, euro 37.4 percent, British pound 11.3 percent and Japanese yen 9.4 percent of the weight. The revision of weights was based on the value of the exports of goods and services by the country or currency zone, and the amount of reserves denominated in the respective currencies held by the IMF members. Under the new weightings, RMB will have a share of 10.92 percent in the basket while euro’s share will drop to 30.93 percent followed by British pound and Japanese yen which would also have lower weights. Dollar’s weight would, nonetheless, remain almost the same. In order to meet the required criteria, China had undertaken several reforms in recent months, including a better access to Chinese currency markets by foreigners, more frequent debt issuance and expanding Yuan trading hours. RMB has also to remain “freely usable” or widely used currency to make international payments and widely traded in foreign exchange markets. It means that, unlike the past, China has to maintain the value of its currency market determined and ensure a free movement of RMB across the borders. Keeping in view the present strength and the potential of Chinese economy, these criteria would not be very difficult to meet. Developing countries could benefit to a certain extent from this development because China would now be much more inclined to adjust the RMB value in line with the market forces which could help in expanding their exports. Also, they could have another avenue to diversify their foreign exchange reserves.

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