The renminbi is poised to further advance its status as a global reserve currency, as it is now a prime candidate for inclusion in the IMF reserve assets basket, with likely profound implications for renminbi internationalization. Oswald Chan examines the likely scenario.

For the first time ever, the renminbi has a good chance of getting International Monetary Fund (IMF) endorsement to be included in the Special Drawing Rights (SDRs) reference basket of currencies. Later this year, the IMF will conduct its twice-a-decade review of the SDR basket to decide whether to include fresh currencies in the reserve asset.

Including the renminbi in the SDR system would allow the IMF to recognize the rise of the Chinese mainland economy while helping China's attempts to reduce the dominance of the US dollar in global trade and finance.

Liu Hong, economist at Bank of China (Hong Kong) (BOCHK), is optimistic about the renminbi being added to the SDR currency basket in the coming IMF review.

"China is already the world's largest trading country, accounting for 12 percent of global trading volume. The renminbi has therefore met the first criterion, that the currency-issuing country acquires the top global position in goods and services export in the preceding five years," Liu noted.

"Second, the renminbi, as the world's sixth-largest foreign exchange currency and seventh most-used payment currency, has also fulfilled the second criterion, that the currency should be widely used in international payments and widely traded in the major foreign exchange market," he added.

"An important indicator of the renminbi's maturity would be its inclusion in the IMF's SDR basket of reference currencies," HSBC Greater China economist John Zhu said. "China's increasing share of world trade and gross domestic product (GDP) would clearly justify greater use of the renminbi."

"Chinese economic stability in the form of low inflation, small budget deficits and steady growth is also important. The Chinese government is giving strong official and institutional support to the pursuit of renminbi internationalization and opening up of the country's capital account," he added.

The IMF created the SDR system in 1969 to support the Bretton Woods system of fixed exchange rates after supplies of the key reserve assets, gold and the US dollar, proved inadequate for supporting the expansion of world trade and financial development. The US dollar, the euro, the UK pound and the Japanese yen are the four reference currencies in the SDR basket.

About $309 billion SDRs are outstanding globally, according to information on the IMF website. The value of SDR assets is calculated as the sum of specific amounts of the four basket currencies valued in US dollars, on the basis of exchange rates quoted each day in the London market.

In tune with times

The SDR basket is crucial in providing liquidity to the global financial system and supplementing IMF member countries' official reserves, such as during the global financial crisis of 2008. Member countries can utilize their SDRs to buy domestic currencies in the foreign exchange market to support the exchange rate of their own currencies.

The IMF every five years reviews whether to broaden the SDR currency basket. In 2010, the IMF regarded the current SDR composition as still appropriate. IMF managing director Christine Lagarde mentioned the renminbi would be included in the SDR currency basket in due course.

The major uncertainty is that the US may exercise its veto power on this issue. But analysts have predicted the US would be unlikely to do so because the inclusion of the renminbi can strengthen IMF functions, which will also benefit the US.

There are also worries that the renminbi does not have enough market depth and liquidity since it is a managed currency and the Chinese central bank's interventions would make it less transparent than some reserve managers would like.

The People's Bank of China (PBOC) has lately been trying to assuage such fears through a series of swap agreements with other central banks. More than 20 central banks have already signed currency swap agreements with the PBOC worth around 2.5 trillion yuan ($402 billion) to allow foreign central banks to tap a steady source of renminbi liquidity to serve their local market needs.

There are now five offshore renminbi financing centers - Hong Kong, Singapore, London, Paris and Taiwan - to facilitate renminbi currency flows.

The addition of the renminbi into the SDR currency basket will facilitate international monetary system reforms, economists believe.

"Adding the renminbi into the SDR currency basket can reflect the increasing weight of emerging markets in the global economy and financial market. Secondly, it can realize the IMF target to include multiple currencies in the foreign reserves, reduce overdependence on the US dollar and increase the stability of the international monetary system." BOCHK's Liu reckoned.

According to international currency flows monitor organization SWIFT (Society for Worldwide Interbank Financial Telecommunication), the renminbi overtook the euro to become the second most-used currency in global trade finance after the US dollar in December 2013. According to HSBC, the renminbi was the seventh most-used currency for payments worldwide as of February 2014.

And the Bank for International Settlements Triennial Central Bank Survey shows the renminbi in April 2013 became the ninth most-traded currency in the global market, with turnover surging to $120 billion, or 2.2 percent of the global trading volume.

Looking ahead, ANZ Bank believes renminbi internationalization will continue to advance in 2015 due to the Chinese government's various measures in liberalizing the capital account (see table).

Out and about

The investment bank projects the daily foreign exchange turnover of the renminbi to reach $3.4 trillion, equivalent to 16 percent of China's GDP, in 2020, compared to $80 billion or 0.8 percent of GDP in 2013.

Royal Bank of Scotland (RBS) also expects the Chinese government to continue to push forward renminbi internationalization.

"Given the already large scale of China's economy and foreign trade as well as prospects for further solid expansion, potential demand for the renminbi's international usage is large," RBS chief China economist Louis Kuijs said.

"Moreover, the increased focus of corporations and Chinese government on 'going out' should support renminbi internationalization," he said.

According to HSBC data, the renminbi is now used to settle 18 percent of China's total trade, with more than 10,000 financial institutions doing business in renminbi.

Contact the writer at oswald@chinadailyhk.com

(HK Edition 01/23/2015 page1)