China is set to see its currency, the yuan, officially called renminbi, being added as a reserve currency this year, according to Bloomberg.
A recent survey conducted by Bloomberg shows that eleven out of sixteen economists have predicted that the International Monetary Fund (IMF) will add the Chinese currency to its Special Drawing Rights (SDR) basket during a review this year.
The composition of the SDR basket is reviewed every five years. In 2010, the IMF decided that the yuan could not be added due to the fact it wasn’t “freely usable” at the time.
The IMF created the SDR basket back in 1969 to support the Bretton Woods system of fixed exchange rates after supplies of gold and dollars proved inadequate. Owning SDRs gives countries a claim to the four currencies in the basket: the dollar, euro, yen, and UK pound.
China’s yuan has recently emerged as one of the world’s top five payment currencies, overtaking the Canadian dollar and the Australian dollar, according to global transaction services organization SWIFT (The Society for Worldwide Interbank Financial Telecommunication).
The Push to Include the Yuan Into the SDR Basket
For over five years, China’s Central Bank Governor Zhou Xiaochuan has pushed for the yuan to be included into the SDR basket, a move that would aid China’s attempts to diminish the dollar’s dominance in global trade and finance.
To aid its efforts, China has ramped up its efforts to make the yuan more freely usable, in order to be considered for inclusion into the SDR basket.
Chinese Premier Li Keqiang told IMF Managing Director Christine Lagarde in March that China would speed up the basic convertibility of yuan on the capital account and provide more facility for domestic individual cross-border investment and foreign institutional investment in China’s capital market.
Li also said that China hoped to — through the SDR — “play an active role in the international cooperation to maintain financial stability and promote the further opening of China’s capital market and financial area.
In March, China announced that its long-awaited global payment system to process cross-border yuan transactions was ready and could launch as early as September.
The launch of the China International Payment System (CIPS) will pave the way for further internationalizing the yuan and should greatly increase global usage of the Chinese currency by cutting transaction costs and processing times.
CIPS, will be a global payments superhighway for the yuan and will replace an assortment of networks that make processing renminbi payments a more cumbersome process.
CIPS will allow for companies outside of China to clear yuan transactions with their Chinese counterparts directly, thus reducing the number of stages that a payment needs to go through.
Currently, the U.S. dollar has a 41.9 percent weighting in the SDR basket, with the euro holding a 37.4 percent weighting, according to the IMF’s website. The pound accounts for 11.3 percent and the yen accounts for 9.4 percent.
What to Expect if the Yuan is Included Into the IMF’s SDR?
If included into the SDR basket, the Chinese yuan could have a potential weighting of around 13 percent, according to an estimate by Bank of America Merrill Lynch in March. HSBC believes that the yuan’s share could be around 14 percent, reflecting China’s importance in global exports, according to a report published in April.
“What is significant is the seal of approval by the IMF that the yuan has internationalized as a reserve currency,” Aidan Yao, senior emerging market economist at AXA Investment, told Bloomberg in May. “It could trigger a reallocation of global reserves portfolios.”
According to Standard Chartered, around $1 trillion in global currency reserves will switch into Chinese assets should the International Monetary Fund (IMF) endorse the yuan as a reserve currency and include it in its in the Special Drawing Rights (SDR) basket this year.
“SDR inclusion in 2015 would likely have a significant market impact, driving an immediate sharp increase in global diversification into renminbi assets,” Standard Chartered said in May. “The renminbi broadly meets SDR criteria.”
The Yuan “Clearly Belongs” in the SDR Basket
IMF Managing Director Christine Lagarde said just days prior to her meeting with Chinese Premier Li in March that the Chinese yuan “clearly belongs” in the Special Drawing Rights (SDR) basket.
Lagarde also said that China’s yuan at some point would be incorporated in the SDR basket, and that “It’s not a question of if, it’s a question of when“.
In May, the IMF said that China’s currency was no longer undervalued, given its recent appreciation, but said that the government should pick up the pace in loosening controls on the exchange rate.
Should the Yuan join the IMF’s reserve currency basket — with the ranks of the dollar, euro, pound, and yen — this would allow for China to challenge the dollar’s dominance in global trade and finance.
The U.S. Treasury Department said in a statement on Thursday that China is committed to increasing exchange-rate flexibility and shifting more rapidly towards a market-oriented system. “China pledged for the first time to intervene in foreign-exchange markets only when necessitated by disorderly market conditions,” it said.
The IMF’s SDR review is slated for November with 70 percent of votes likely required to approve the yuan’s inclusion, an IMF official said Thursday.
China’s Struggle to Maintain Growth
Over the past few years, China has struggled to maintain economic growth which has been dragged down by a combination of an industrial slowdown and a weak housing market.
On Wednesday, China’s cabinet, the State Council, proposed a draft amendment to a banking law that would remove a lending cap that has long barred banks from lending more than 75% of their deposits.
In a nutshell, the move would scrap the loan to deposit ratio (LDR) in China, which is a way of regulating bank liquidity, from a legal limit to a mere guideline for commercial banks, thus allowing banks to lend as much as they want in effort to help spur growth.
China’s economic growth in the first quarter (Q1) of 2015 reached the slowest quarterly pace in six years at 7 percent from a year earlier.
In March, China lowered its economic growth forecast to “about 7 percent” in 2015 as the nation adjusts to a “new normal” of slower but more sustainable growth.
A full-year growth rate of 7 percent would be its slowest annual rate of expansion in 25 years.