On Oct 1, the RMB officially joined the currency basket of the Special Drawing Right (SDR). The inclusion of the RMB into the SDR not only marks an important milestone of accelerating a comprehensive opening up of China’s financial system and helping globalize the RMB but will also influence the SDR global operation mechanism in many aspects, promoting the reform of the international currency system.
As shown by the IMF World Economic Outlook data, China became the world’s second-largest economy in 2010. The inclusion of the RMB into the SDR will make the SDR more globally representative. Its global representativeness will expand substantially and the SDR itself will have a qualitative change. Second, the fluctuation of the RMB is far smaller than the other currencies, so the inclusion of the RMB will improve the stability of the SDR basket. Third, the inclusion of the RMB provides the member countries with more choices of reserve assets, which meets the need of diversification. Fourth, the inclusion in the SDR will further enhance the attraction of the SDR.
According to the current share allocation, the weight of the RMB in the new basket is 10.92%, lower than the US dollar’s 41.73% and the euro’s 30.93% ,but higher than the yen’s 8.33% and the pound’s 8.09%. However, the allocated weight of the currencies in the SDR basket does not represent the actual currency allocation in the global central banks’ foreign reserve assets. Take the US dollar for an example, the dollar’s weight in the SDR basket is about 42%, but its allocation in the countries’ foreign reserve assets is as high as 64%, much higher than its weight in the SDR basket. This actually proves that the inclusion into the SDR and the weight in the SDR is more meaningful in form than substance and does not directly determine the internationalization of a currency.
At present, reserve currencies officially confirmed by the IMF are the US dollar, the euro, pound, yen, Swiss franc, Canadian dollar and the Australian dollar. But only four of them are the currencies in the SDR basket.
The inclusion into the SDR grants the RMB a “legitimate” status officially recognized by the IMF. Not only the RMB is listed as a reserve currency, but also, China can get the total amount of the RMB bought by the central banks from the foreign reserve data regularly published by the IMF. The inclusion of the RMB will be a new starting point towards the financial opening up.
Before and after the SDR evaluation, despite its capital market turmoil, China still insisted on pushing forward its financial reform and opening up， and the progress was possibly the quickest in all the reform areas. Throughout the reform in recent years, China’s central bank did much homework in order to meet the requirements of the SDR for a convertible currency.
The inclusion of the RMB can strengthen China’s international purchasing power. Now, RMB offshore clearing banks have expanded to 22 countries and areas, forming a clearing network covering the five continents. China actively adjusts the RMB central parity rate formation mechanism, reduces the degree of deviation of the RMB central parity exchange rate from the market price and promotes the establishment of the Cross-border Inter-bank Payment System (CIPS). Now the RMB clearing banks have been set up in the US, Britain, Germany, France and elsewhere. Since the beginning of this year, China’s central bank has successively opened the inter-bank bond and foreign exchange markets to the foreign central banks, gradually increased Qualified Foreign Institutional Investors (QFII) and Qualified Domestic Institutional Investors (RQDII) as well as other investors, and expanded the investment products. Shanghai-Hongkong Stock Connect was already launched and the Shenzhen-HK Stock Connect is coming soon. Thus the interconnection between the mainland and Hongkong capital markets will be reinforced.
However, in essence, if the RMB will take the functions of pricing, clearing and reserve as an international currency, China needs to continue improving the RMB’s attraction as a financial transaction currency. The fundamental reforms such as marketizing the exchange rate and opening up the capital market should be carried on in the future.
The global central banks will very much likely increase the RMB reserve as the RMB becomes a new reserve currency in the SDR basket. China is actively seeking a wider use of the SDR, including the bonds denominated in the SDR. Internationally, China’s mid-and long-term potential economic growth rate and the treasury yields are still higher than those of the developed countries, meaning that China’s assets are still very appealing to the global capital.
At the same time, if SDR bonds are settled in RMB, more RMB will be used in the financial settlement correspondingly. If the RMB exchange rate reform and the opening of the capital account can be smoothly carried on, market orientation force will gradually get stronger, exchange rate will be further flexible; the financial market will enjoy stronger market depth and get more brisk. Affected by all this, all kinds of RMB international debts, international bonds and trade financing will quickly grow, thus further stimulating the global offshore markets including Hongkong.
From a long-term perspective, it means that the RMB internationalization will be more driven by being used in pricing and as reserve currency rather than by cross-border trade settlement in the future.