16 January 2019
An employee examines a stack of yuan notes in a bank in South Korea. China has currency swap arrangements with 25 foreign central banks. Photo: Bloomberg
An employee examines a stack of yuan notes in a bank in South Korea. China has currency swap arrangements with 25 foreign central banks. Photo: Bloomberg

How SDR status can boost renminbi internationalization

Watch out for a possible major boost for renminbi internationalization later this year when the International Monetary Fund (IMF) reviews the components of the Special Drawing Rights (SDR) facility.

SDR is an international reserve currency basket managed by the IMF consisting of the US dollar, euro, British pound sterling and Japanese yen.

There has been speculation that when the IMF reassesses the weightings of these currencies in November, it may add new currencies such as the renminbi to the currency basket.

On March 12, during the National People’s Congress in Beijing, central bank deputy governor Yi Gang said China is hoping the renminbi would be included in the SDR as a component reserve currency.

Becoming an SDR component currency is a fast track to international reserve status for the renminbi.

However, the direct global effect of having the currency in SDR will not be significant in the short term.

This is because SDR accounts for only 5 percent of global official reserve asset holdings and it is not a currency, so adding the renminbi to the SDR basket will not have any material impact on international trade and financial transactions.

At present, the US dollar, euro, pound sterling and yen account for 42 percent, 37 percent 11 percent and 10 percent, respectively, of the SDR basket.

If the renminbi were to be included, it is unlikely to command a share larger than the pound sterling or the Japanese yen.

So central banks’ demand for the renminbi via SDR will be negligible in global terms.

Technically, the renminbi cannot be an SDR component by the IMF’s balance-of-payments definition of a “freely usable currency”.

However, the notion that a freely usable currency ought to qualify for the SDR basket has been intensely debated.

First, it does not strictly mean full currency convertibility.

Second, the renminbi has already met some of the conditions for a freely usable currency.

Notably, it has been fully convertible on a current account basis since 1999 and is being increasingly used in international trade settlement and in the denomination of offshore deposit accounts since 2009.

Setting up clearance arrangements for renminbi transactions and establishing currency swaps with foreign authorities are two essential steps to deepen renminbi internationalization.

Beijing has set up renminbi swap agreements with 25 foreign central banks, with the number of these agreements expected to grow in the coming years.

The incentive to use the renminbi overseas will only increase if it can be settled and cleared with convenience, sufficient liquidity and low transaction costs.

The swaps are an alternative way to increase renminbi outflows to overseas markets, hence enlarging the offshore renminbi pool, before China fully opens up its capital account.

When the progress of China’s financial reform and political considerations are taken into account, the game may change in Beijing’s favor for including the renminbi in the SDR basket.

However, with the global influence stemming from the renminbi’s  SDR status expected to be limited, why is Beijing so keen about SDR?

The reason lies in Beijing’s vision for structural reform.

So far, renminbi internationalization has proceeded at two different speeds.

Beijing has made good progress on the international trade settlement front, with the renminbi now the fifth most-used trade settlement currency, according to SWIFT.

But in absolute terms on a global scale, it is still a minor currency.

Meanwhile, it has made slow progress in promoting the renminbi for financial transactions.

Outside of Hong Kong, renminbi transactions have remained minimal.

SDR status can be a game changer for all this.

Even the prospect of the renminbi becoming an SDR component currency with an increasing weight might create a virtuous cycle where anticipation of deeper internationalization (stemming from being an SDR component) would prompt more central banks to hold the currency which would then actually deepen its internationalization and prompt more central banks to hold more of it.

The cycle could snowball and increase the weighting of the renminbi in global reserve allocations.

Global equity and bond indices will also include renminbi assets in their components, so international asset managers will have to include renminbi assets in their portfolios.

All this will, in turn, facilitate renminbi international payments for trade and financial purposes.

Since major structural changes are needed to fully internationalize the renminbi, the ultimate goal is to use it as a means (an external force) to achieve structural reform success, the end goal of China’s liberalization process.

Opinions expressed here are the author’s and do not necessarily reflect those of BNPP IP

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Senior economist of BNP Paribas Investment Partners (Asia) Ltd. and author of “China’s Impossible Trinity – The Structural Challenges to the Chinese Dream”

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