The IMF and the renminbi: China’s coming of age

The IMF’s expected welcoming of the renminbi into an exclusive currency club is a significant acceptance of China’s position as a global financial player. Simon Wilson reports.

What’s happened?

What matters is what’s about to happen – in particular what will take place on Monday at a board meeting of the International Monetary Fund (IMF). The Board is expected to agree to include the Chinese currency, the renminbi, in the basket of four reserve currencies used to value its own de facto “currency”, the SDR (“special drawing rights”). It would be the first time since 1999, when the euro replaced the deutschmark and the French franc, that the make-up of the SDR basket has changed. China has been lobbying for the move for years, and it has great symbolic importance in terms of the country’s integration into the global monetary system. It means, in effect, that the IMF is lending its imprimatur to the renminbi (or yuan) as a legitimate global reserve currency.

What are “special drawing rights”?

They are the IMF’s internal unit of account, defined by the Fund itself as “an international reserve asset created by the IMF in 1969 to supplement its member countries’ official reserves” in order to support the expansion of world trade. The IMF admits that two developments have significantly lessened the importance of the SDR – the shift of major currencies to a floating exchange rate regime; and growth in international capital markets, facilitating lending to creditworthy governments. However, it also notes that, post-2009, IMF funds totalling SDR182.6bn (around $250bn) “played a critical role in providing liquidity to the global economic system and supplementing member countries’ official reserves amid the global financial crisis”.

How much is an SDR worth?

The value changes in line with the values of the four currencies in the basket: the US dollar (on a 41.9% weighting), the euro (37.4%), sterling (11.3%) and the Japanese yen (9.4%). Currently, an SDR is worth about $1.37. But the SDR’s importance is not its worth in terms of dollars, but what it signifies in terms of the currencies included and their relative weightings. Every five years the IMF adjusts the weightings to take account of their prominence in terms of international trade and national currency reserves. In other words, the make-up of the SDR (also abbreviated to XDR) represents the balance of power in global financial markets – and China reckons it’s time it joined the top table.

What are the criteria for inclusion?

There are two preconditions: a country must by a big exporter; and its currency must be “freely usable” and widely used. The first is non-controversial: China has been the world’s biggest exporter since 2009. The second is more contentious. If “fully usable” were to be interpreted as “fully convertible”, the renminbi would not make the cut. China has significant capital controls and limits on foreign investment in capital markets, and its central bank’s explicit goal is to move its currency towards “managed convertibility” only. But in reality, the phrase “fully usable” is a piece of IMF-speak dating back to 1978, when both the UK and France also placed restrictions on cross-border flows; the latitude designed to keep in the Europeans in the club is now being used to bring China in too.

But is the renminbi widely used?

Not as much as other SDR currencies. Last year it ranked seventh in countries’ official reserves, eighth in international bond issuance and 11th in global currency trading. The direction of travel is clear: global transfer system SWIFT reports that it has gone from being the 20th most-used currency for cross-border payments in 2012 to the fifth today. But this, argues Christopher Balding on BloombergView.com, overstates its usage as a global currency. “More than 70% of payments made in yuan still go through Hong Kong [and] all but 2% of yuan-denominated letters of credit are issued to Hong Kong, Macau, Singapore, and Taiwan to facilitate trade with China.”

So is this purely symbolic?

The symbolism is important, but only because it reflects a real-world shift in power. The IMF’s move does not mean the renminbi will suddenly rival the dollar as the world’s de facto reserve currency. The outstanding value of SDRs is around $300bn, about 2.5% of global currency reserves. The renminbi would make up just a small portion of that, and in any event it is extremely rare for countries to make payments in SDRs. Yet the IMF’s high-profile backing for the renminbi would likely make central banks and institutional investors feel more comfortable about holding reserves in the renminbi. According to analysts at Standard Chartered, if the IMF does bring the renminbi into the SDR, investors will allocate an extra $1trn to Chinese assets.

What’s in it for the IMF?

The IMF has two good motives for elevating the renminbi, reckons The Economist. First, the People’s Bank of China has been the “strongest proponent of financial reform in China” – some of it geared towards SDR entry. “Bringing the yuan into the SDR would strengthen its authority and spur it to do more”; rejecting it would do the opposite. Second, the move is “as significant for the IMF as it is for China”. Reforms to the IMF to give emerging markets more voting power have been “held up for years by America’s dysfunctional politics, and in any case do not go far enough”. The SDR would be a decent “consolation prize” for China, and would help to bolster the Fund’s own legitimacy in the eyes of developing economies.