The RMB is moving steadily towards becoming a truly international currency
On 1 October, the renminbi begins a new chapter in its journey towards becoming a global currency. The Chinese currency will officially enter the IMF’s Special Drawing Right (SDR) currency basket, joining the US dollar, the euro, the Japanese yen and the British pound in an elite club.
The IMF’s decision to admit the RMB is a seal of approval, signifying that the RMB is widely used and widely traded, even though it is still subject to some capital account restrictions.
A currency does not need to be part of the SDR basket to become a reserve currency. Similarly, SDR inclusion does not automatically translate into reserve-currency status. It is ultimately up to central banks to decide whether to hold assets denominated in a particular currency – and how much to hold.
What, then, is the significance of China’s currency joining the SDR basket?
First, it is a recognition of the RMB’s development as a global medium of exchange. The currency is now both widely used (ranked fifth by SWIFT, a network that banks around the world use to move money) and widely traded (ranked eighth by the Bank for International Settlements, a central bank for central banks).
By 2020 half of China’s trade will be settled in its own currency
More importantly, admittance into the SDR basket suggests that the RMB’s role in the global arena will continue to expand.
The RMB’s current share of global payments is less than 2 per cent, whereas the dollar and the euro together account for more than 70 per cent. As companies and investors step up their use of the Chinese currency, the RMB’s share will rise.
We believe that by 2020 half of China’s trade will be settled in its own currency, up from 26 per cent in 2015. Improved payment systems will help, while the IMF’s seal of approval should boost confidence that the RMB is liquid and stable as a store of value.
The RMB’s share of global central bank reserves will also increase. At the moment, the dollar and the euro together account for nearly 85 per cent of the world’s reserves, while the RMB is not even recorded in the IMF’s regular surveys on central bank holdings. From 1 October, this will change: the RMB will be separately identified in the IMF’s official reserves database.
Meanwhile, gradual liberalisation is opening up new ways that overseas investors – including central banks – can buy RMB-denominated assets.
Take the recently-announced Shenzhen-Hong Kong Stock Connect scheme. This expands the list of Mainland-listed companies that overseas investors can trade in; it also widens the range of Hong Kong-listed stocks that Mainland investors can buy and sell.
Or take China’s domestic bond market: last year China reopened the so-called panda bond market, allowing foreign entities to issue RMB-denominated debt on the Mainland. In February, the authorities opened the China Interbank Bond Market up to investors such as foreign banks and pension funds. And in August, the World Bank became the first entity to receive approval to issue SDR-denominated bonds in China.
In many ways, October 1 2016, represents the culmination of more than a decade of change for what was once an almost exclusively domestic currency. But it is also the beginning of a new chapter: more change will come, as the RMB moves steadily towards becoming a truly international currency that is used by companies, investors and individuals around the globe.
A version of this article first appeared in The Australian Business Review on 23 September 2016.