Renminbi inclusion in the SDR: Why does China want it to become a reserve currency?
On November 30, the Executive Board of the International Monetary Fund (IMF) has approved a recommendation to include the Renminbi in the basket of currencies that compose the SDR (Special Drawing Rights — an international reserve asset used only by central banks, the IMF and a few other official institutions). The RMB will therefore join four other currencies (USD, EUR, GBP and JPY) in this perceived exclusive club. The RMB’s share in the SDR basket will be 10,9%. This decision will take effect by 1 October 2016. By approving the RMB inclusion, the IMF has formally expressed the view that the currency meets the criteria for SDR inclusion.
Potential Benefits for China
SDR inclusion does not automatically confer reserve currency status, which is ultimately determined by the willingness of foreign central banks to hold the issuer’s currency and financial instruments. It is only one small step toward reserve currency status, which is ultimately determined by the voluntary use of the currency. In the opinion of State Street Global Advisors, the advantages of reserve currency status include:
– Better financing, i.e. the ability to borrow in one’s currency both domestically and internationally
As a reserve currency, both sectors in China would be able to issue most of their debt in RMB, removing the potential exchange rate risk that could suddenly trigger a balance of payments crisis with a spike in debt servicing costs. In addition, an expected outcome would be increased liquidity in domestic capital markets, creating more diverse financing options at competitive rates.
– Seignorage.
This phenomenon refers to income earned by a central bank by issuing currency that others wish to hold. In practice, the Chinese central bank would earn seignorage by issuing a non-interest bearing liability — cash — while being able to invest in Chinese government bonds.
– Lower transaction costs and the ability for Chinese companies and individuals to pay for purchases in their own currency.
– Policy flexibility.
The lower borrowing costs impose less market discipline on the fiscal policy of reserve currency holders.
– Reduced reliance on the US dollar, and facilitation of the overseas expansion of Chinese firms and financial institutions.
– Financial Market Development.
recisely because reserve currencies need to be able to draw on deep financial markets, with a healthy supply of denominated financial assets, especially fixed income securities, it implies that China would have to advance the development of its financial system.
– Consumption boost.
The general expectation is that the RMB’s increased usage as a reserve currency would be accompanied by a rise in its value over the long term. If correct, this would help boost Chinese consumption by lowering import costs, as well as help improve consumer finance.
– Geopolitical prestige and influence.
A large part of China’s motivation to ensure SDR inclusion of the RMB this year is for political prestige. Official designation and unofficial recognition of the country’s currency carries large symbolic weight.