The Chinese renminbi is increasingly used for international trade and investment
On 30 November, the International Monetary Fund announced that the renminbi will be included in its basket of so-called Special Drawing Rights (SDR), putting the Chinese currency on a par with main reserve currencies such as the US dollar and the euro.
The move represents a major step along the renminbi's path from a national currency to an international one.
Just over a decade ago, renminbi usage was largely confined to mainland China.
The move represents a major step along the renminbi’s path from a national currency to an international one
Now, more than a quarter of China's trade is settled in renminbi. Cross-border schemes allow foreign investors to buy stocks and bonds in mainland China. A large pool of offshore renminbi is freely convertible for trade payment and investment.
The SDR inclusion – long an aspiration for policymakers in Beijing – sends several important messages.
It underlines how far the Chinese currency has come, vindicating Beijing's financial-market reforms to date. It serves as a sign of long-term quality assurance, underlining that the currency is liquid and stable as a store of value. And it will give greater confidence to companies and institutions around the world to trade and invest in renminbi.
Inclusion in the SDR basket will prompt some central banks to adjust their holdings of the Chinese currency. The renminbi has been assigned a 10.92 per cent weighting in the SDR basket, higher than that of the pound and the yen. Central banks and reserve managers who hold assets denominated in SDRs, or who match their reserves to the SDR, will need to adjust their renminbi holdings accordingly.
According to a survey of central banks carried out earlier in the year, the renminbi will make up an estimated 2.9 per cent of foreign-exchange reserves by the end of this year and will account for 10 per cent of world reserves by 2025.
The SDR inclusion is also likely to encourage financial and capital account liberalisation.
In the run-up to the International Monetary Fund's review of the SDR basket, policymakers in Beijing stepped up financial reforms in a bid to attain inclusion.
In July, the People's Bank of China made it easier for other central banks, sovereign wealth funds and international financial institutions such as the World Bank to invest in China's inter-bank bond market. In August, the authorities gave market forces a greater role in how the central parity rate of the renminbi against the US dollar's daily trading band is determined. And in October, China increased the quota for how much South Korean institutional investors can invest through the Renminbi Qualified Foreign Institutional Investor (RQFII) scheme, while in November, China increased Singapore's RQFII quota and designated Malaysia as a new RQFII participant.
The SDR inclusion is likely to prompt more moves by China to progressively open its doors to two-way capital flows. A Shenzhen-Hong Kong equivalent of the Shanghai-Hong Kong Stock Connect, which allows investors from both sides direct access to each other's market, is in the works. So is a scheme that will start allowing retail investors in mainland China to invest overseas.
As China seeks to rebalance its economy towards more consumption, services and higher-value manufacturing, it needs a more open capital account: liberalisation will help support economic growth, improve the allocation of capital, and help bring down borrowing costs. The SDR inclusion is another step in this important and fundamental change.
A version of this article appeared in the South China Morning Post on 7 December 2015.