IMF Managing Director Christine Lagarde announced on Dec.1 that having met IMF’s “freely usable” criterion, the RMB could be officially included in the SDR currency basket and the decision would take effect on Oct. 1, 2016.
The inclusion of the RMB in the SDR basket basically establishes China’s economic status in the global market, a milestone for China. It not only helps China demonstrate its economic and financial power in the world, but also helps increase the demand of all central banks and the investors to hold the RMB. It is also global affirmation of China’s achievements in its market economic reform over the past decades and will be conducive to promoting China’s future financial reform. Meanwhile, inclusion in the SDR basket not only helps boost the process of RMB internationalization, but also creates a new situation in the international financial market, making the SDR currency basket more representative and more legitimate.
More importantly, under the current conditions, the inclusion of the Chinese currency in the SDR basket also means that it has eliminated the technical barriers for all central banks to hold RMB as an international reserve currency while RMB has not had full convertibility and a completely open capital account. It reinforces RMB’s international market position in cross-border transactions and in investment settlement. It helps Chinese enterprises reduce their financing costs in the world market, facilitate the opening of the capital account and lower the big risk from a possible impact of the international market when a fully convertible RMB is required.
At the same time, the inclusion of the RMB in the SDR basket also means that China will start to assume its responsibility as an international market power, such as further promoting financial reform, making the exchange rate mechanism more flexible, making the central bank’s monetary policy more independent and the capital account more open. The Chinese government will make more changes in RMB management and in exchanges with investors and the world because the overseas market will ask for more in China’s financial reform and RMB management. It helps increase RMB’s intrinsic and extrinsic value, accelerating the currency’s internationalization.
After the inclusion of the RMB in the SDR, the issue that the world focuses on is how much RMB the central banks and the investors in the world market will need as a reserve currency. Some analysts believe that if calculated on the basis of 10.92% weight in the SDR basket, the RMB that all central banks will need as reserve asset could reach about $660 billion. But this potential demand is not an actual one. The RMB that the world potentially needs will not necessarily all turn into the foreign reserve held by the overseas central banks. The Chinese government needs to make more efforts in all aspects in order to convert the potential demand into an actual one.
After the inclusion of RMB in the SDR basket, two questions arise. First, is that inclusion good or bad for the Chinese financial market? In the long run, the inclusion of RMB in the SDR basket is a great thing for China’s economic and financial reform. However, its influence and impact on China’s economy is more psychological than physical. Established by IMF to guarantee world liquidity, the SDR is only an account unit instead of a real currency, which must be converted into another currency within the SDR basket and cannot be used in direct payment and settlement. So, after the inclusion of the RMB in the SDR basket, the statement that the demand for the RMB in the overseas market will increase is only based on the RMB’s weight in the SDR basket. But the size of the actual demand for the RMB as a reserve currency is uncertain. It depends on the judgment of all central banks and the investors on the future trend of the RMB. Therefore, the short-term impact of the inclusion should not be overestimated.
Second, in the wake of the inclusion, will the RMB return to the track of bilateral appreciation with the increasing overseas demand for the RMB as analyzed by some foreigners? The actual market indicates a different market response. Since November, the offshore RMB (CNH) and the onshore (CNY) exchange rates have turned weak, now reaching the lowest level in nearly five years. It means that after the inclusion of the RMB in the SDR basket, both the domestic and the foreign markets do not believe that the RMB will again go to the unilateral appreciation track and they expect a weak RMB’s future trend instead.
The domestic and foreign markets give a very clear analysis that the existing relatively stable RMB is entirely the consequence of many interventions by China’s central bank for the sake of the inclusion of the RMB in the SDR basket. After the apparent inclusion of the RMB in the SDR basket, China’s central bank will surely pay a high cost if it wants to maintain the stability of the RMB, which could make China’s central bank give up its excessive interventions in the RMB in the future. Thus, the future trend of the RMB will more depend on China’s present economic fundamentals. If China’s economic growth is still under a big downward pressure and China’s central bank further imposes an easy monetary policy, the RMB will go through an increasing pressure of depreciation. Added to this is the Fed’s rate rise which will even more increase the chance of the RMB depreciation. Therefore, the inclusion of the RMB in the SDR basket is a double-edged sword. We should not overestimate its significance and impact, particularly within the short term.