By Dr. Hui Feng
The Executive
Board of the International Monetary Fund (IMF) has decided to
include the renminbi (RMB) in its basket of reserve currencies. The RMB, or
yuan, has joined the US dollar, Euro, British pound and Japanese yen to become
the fifth member of the basket used to value the Fund’s own de facto currency,
the Special Drawing Rights (SDRs).
Image Attribute: Renminbi Currency Notes / Source: Wikimedia Commons
More than a
membership
On the
surface, the impact of the decision looks relatively
modest. The value of the SDR will be based on a weighted average of the
values of the basket of currencies. Only about 2.5% of the US$11.5 trillion of
foreign reserve assets are held in the form of SDRs, of which the RMB is
expected to account for 11% of the basket (higher than the yen and the pound).
Looking more
broadly, however, the inclusion of the RMB (aka the “redback”) in the SDR’s
currency basket is bound to have profound implications.
Apart from the
RMB’s new acceptance in international trade, settlement and investment, the
ultimate aim is to be accepted as a reserve currency, used by central banks to
hold foreign exchange reserves. It is estimated that
the SDR inclusion should lead to about US$42 billion of reserve assets being
rebalanced into the RMB by central banks and reserve managers, in the medium
term.
According to
the IMF,
the move is “an important milestone in the integration of the Chinese economy
into the global financial system”.
It is also an
important milestone in Beijing’s campaign to internationalize the yuan. As
Robert Mundell, “father of the Euro”, declared,
“great powers have great currencies”.
For China,
this is an essential step in fulfilling its ambition to crown the yuan a global
reserve currency. In fact, the RMB is the first currency not issued by a major
advanced economy to make it to the IMF basket. More importantly, the IMF’s
decision comes at a crucial time for the Chinese leadership as it seeks to
demonstrate to constituents international recognition of China’s rise as a
global power.
Whatever it
takes
The IMF’s RMB
decision also sets a precedent for the SDR basket that a basket currency is not
yet fully convertible and under capital control from its issuing country. This
has led to criticism that
the IMF is “bending the rules” in favour of China.
The IMF, on
the other hand, sees the move as a reward of “the progress that the Chinese
authorities have made in the past years in reforming China’s monetary and
financial systems”. Indeed, the SDR inclusion has arguably been the most
attractive lure for Beijing to undertake a series of reforms of China’s financial
regime.
In order to
meet the IMF’s criteria of “freely usable”, China took a “whatever it takes”
approach. It liberalized domestic interest rates, aligned the RMB’s exchange
rate more along its market value and opened up the interbank market to foreign
central banks and sovereign funds. Its treasury even issued short-term
(three-month) bonds in order to complete the yield curve for RMB assets, which
was seen as a prerequisite for the RMB’s SDR inclusion. Efforts have also been
made via some closed-door financial diplomacy to lobby IMF member countries for
the RMB’s case.
The last
mile
Member
countries and the market will now make preparations ahead of the October 1,
2016 date for inclusion of the RMB. It may be the last mile for the RMB’s SDR
journey, but there is still a long way to go to launch the redback in the
global arena.
Beijing may
have convinced the IMF, but a more daunting challenge will be to convince the
market. To do so, Beijing needs to demonstrate its commitment to continuing
financial opening and liberalization, to credible monetary management, and to
independent decision making on the part of its financial regulators. In other
words, the reforms must go on.
With the long
awaiting inclusion of the RMB by the IMF, the external world has lost a vital
leverage in empowering reformers and inducing domestic reform in China. Without
external pressures, only the internal momentum of the reform will allow the RMB
to walk the last leg towards true internationalization.
About The Author:
Dr Hui Feng is
a research fellow at the Griffith Asia Institute. Dr Feng’s research looks at
the political economy of post-communist transition with an empirical focus on
China. Before joining Griffith, Dr Feng was a research fellow at the University
of Queensland. He has published in prominent journals such as Political Studies
and Review of the International Political Economy, and is the winner of the
Harrison Prize for best paper published in Political Studies in 2014. His most
recent book is The Rise of People’s Bank of China: the politics of
institutional change (with Stephen Bell, Harvard University Press, 2013). His
forthcoming books are on China's banking reform (in manuscript) and capital
account opening (edited volume with Imperial College Press).
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Publication Details:
This article was first published at The Conversation on December 1, 2015 under Creative Commons License 4.0