The Chinese currency’s path to internationalisation has been stellar so far, but something is happening next year which could propel the renminbi (RMB) into the currency stratosphere.
The IMF’s Special Drawing Rights (SDR) – a basket of currencies reviewed every five years – rarely warrants much excitement, but if the RMB gets included in 2015, alongside the dollar, euro, pound and yen, it could boost the currency’s fortunes overnight.
Automatically, all central banks would become holders of RMB exposure through their SDR assets, and the official recognition of the RMB’s reserve currency status would spur RMB investment by central banks all over the world.
Last time the IMF reviewed the composition of the SDR it concluded the RMB did not meet the key criteria
Moreover, the sheer magnitude of Chinese exports (China is the world’s largest exporter of goods and services), would send the RMB straight past the yen and the pound to make it the third-highest-weighted currency in the SDR. It is hard to overestimate the importance of this move to the global adoption of RMB.
Last time the IMF reviewed the composition of the SDR, in 2010, it concluded the RMB did not meet the key criteria of being a freely usable currency, but a lot has changed since, making next year’s decision much more finely poised.
Getting into the SDR club
Most of the indicators used in determining the ‘freely usability’ of a currency, such as foreign exchange trading volume and RMB payments have experienced significant growth, with RMB now ranked seventh as a global payment currency according to SWIFT data. According to Standard Chartered Renminbi Globalisation Index, the RMB is now 20 times more internationalised than it was at the start of 2011.
These are all factors, which the IMF will have to take into account. Looking at the official reserves of central banks – another important criterion for admission into the SDR club – the IMF may also want to note that, while the amounts remain relatively low, at least 60 of these central banks have already begun to invest in RMB as part of their reserves.
Bank of England also became one of them this autumn when the UK issued its RMB-denominated bond (the first sovereign in the world to do so), and chancellor Osborne confirmed that the proceeds would be kept as part of the UK’s foreign currency reserves. Another recently confirmed central bank investor in RMB is Sri Lanka’s central bank.
Chicken and egg
However, the IMF faces a classic ‘chicken and egg’ situation: until it confers official reserve currency status on to the RMB, there will be no accurate official data showing the proportion of global central bank reserves invested in the currency.
The only way of gauging the overall amount of RMB investment would be to gain information directly from the People’s Bank of China and through informal surveys of market participants.
The fast-paced adoption of the RMB by central banks and the inclusion of RMB in their reserves – underpinned by the Chinese authorities’ continued and conscious efforts in making the RMB more accessible – could help swing the IMF decision in the RMB’s favour.
The final decision is in part discretionary and politics will invariably play a part, but supporters of the RMB’s inclusion may draw comfort from the fact that changes to the SDR composition are relatively ‘easy’ to vote through.
It’s all about percentages
Most big IMF decisions require a 85 per cent majority, effectively giving the US with its almost 17 per cent share of the vote, the power of veto. However, according to Article XV of the IMF’s Articles of Agreements, the IMF Executive Board can make the SDR decision with only 70 per cent of the vote, provided there is no change to the methodology.
Importantly, the Europeans have indicated by their actions that they are unlikely to stand in the RMB’s way, as long as the technical argument stacks up. Recent reports that the European Central Bank is considering adding the RMB to its reserves, joining France and Switzerland who have already decided to do so, is a highly significant development and shows how rapidly attitudes to the RMB are changing.
The significance to central banks
For many central banks, especially smaller ones and those on IMF programmes, the SDR decision will have huge significance. Many of these countries will already be experiencing increased trade with China, making it increasingly sensible for them to hold RMB reserves.
But the fact that RMB investment cannot be reported as part of a central bank’s official reserves means many are holding back from this logical step. At the very least – even if the IMF chooses not to include RMB in the drawing rights – the IMF will need to address this urgent reporting issue.
The decision on whether to officially admit the Chinese currency to the club is not one the IMF will be able to postpone forever
If it doesn’t, by the time the next SDR review comes around in 2020, there will be no official reserve statistics on which to base the decision – despite the fact that by then the RMB is likely to have become the world’s fourth most used trading currency, accounting for close to 35 per cent of China’s trade.
IMF cannot postpone forever
The RMB is very far from challenging the dollar’s dominance as an official reserve currency – more than three-fifths of central bank reserves are still held in the US currency.
But with China now accounting for over 11 per cent of all world trade, and the RMB fast growing in stature, the big decision on whether to officially admit the Chinese currency to the club is not one the IMF will be able to postpone forever.
A version of this article first appeared in FT beyondbrics on 15 December 2014