IMF “Yuans” at Adding Chinese Currency to SDR

August 5th, 2015 by

The push by the Chinese government to have its national currency, the yuan (alternately known as the renminbi, abbreviated RMB), elevated to the status of “reserve currency” has been an ongoing theme ever since the ascendancy of the People’s Republic on the global stage.

yuanGenerally, the path toward achieving such reserve status is the eventual inclusion of the yuan in the IMF’s Special Drawing Rights (SDR), a special unit of account that is calculated based on a basket of major world currencies. Currently, the SDR is made up of the U.S. dollar, the Japanese yen, the euro, and the U.K.’s pound sterling. The weighting of these four currencies is adjusted every 5 years, which is also when the IMF determines if the composition of the SDR (currency symbol XDR) needs to be reconsidered. For instance, the fund has lowered the weighting of the yen in response to Japan’s aggressive devaluation of its currency; it now makes up just 8% of the SDR.

China’s SDR Strategy

By getting its currency included in the SDR basket, China would be sending a strong psychological message to the international markets about the strength, credibility, and global character of the renminbi. Although China has also pushed for gold to be included in the SDR calculation, the IMF has consistently rejected this notion, in part because the creation of Special Drawing Rights in the first place (in 1969) was intended to serve as an alternative reserve for central banks in the event that gold and U.S. dollars (the most popular and trusted foreign reserve assets) are in short supply. Only national central banks can hold SDRs, not private entities.

Source: GoldBroker.com

Source: GoldBroker.com

In this sense, the SDR is not a currency itself. It is a placeholder, a claim on other types of currencies (at the moment, the four included in the SDR basket), and has been used as the IMF’s unit of account.

Because the choice of currencies that make up the SDR basket is intended to reflect the global importance of these currencies in international trade, adding the RMB to the basket would undoubtedly bring the the Chinese currency in closer competition with its peers for use as a reserve currency by various central banks. While this trend has indeed been growing, the yuan still has a way to go before it can be seriously considered.

Case Against the Renminbi

Source: CurrencyGuide.eu

Source: CurrencyGuide.eu

The main knock against including China’s currency in the SDR has been its lack of “full convertibility.” At the moment, the People’s Bank of China still has hard restrictions on flows of capital in and out of the country, although these rules have been easing in recent years. Even with the implementation of various reforms to its economy, few outside observers can confidently say that China won’t arbitrarily change its rules and regulations in the near future. It appears that the IMF would like to wait until more reforms have been undertaken, and are solidly in place, before considering adding the yuan to the SDR.

Moreover, the Chinese government has a penchant for aggressively intervening in its own markets. Though the country has “opened up” significantly over the last 20 years, it still in many cases wants to control economic developments rather than trusting free market forces. This is one of the prime concerns relating to the yuan’s potential reserve status.

Case in Favor of the Renminbi

While there are certainly drawbacks for the IMF to consider, it does seem only a matter of time before these issues are resolved and the yuan is added to the SDR basket. Rather than relying on current data about the currency, which places it just slightly outside the SDR group based on its international use, the fund may take into account the future trajectory for the yuan. It has rapidly become more and more prevalent in international transactions and cross-border capital flows, and has strengthened to an exchange rate of nearly 6-to-the-dollar. According to The Economist, this forward-looking perspective bolsters the case for including the yuan.

The IMF continues to mull over the prospect of the yuan becoming a viable reserve currency. Some traders believe that, although the currency has remained fairly steady in forex trading, that the foreign exchange markets could have a field day with the renminbi if the IMF ultimately rejects China’s request for inclusion.