The Chinese renminbi will be included in the Special Drawing Rights basket of currencies of the International Monetary Fund from Oct. 1.
The IMF has revised the methodology for determining the currency weights in the SDR basket, in order to pave the way for the inclusion of the Chinese currency.
In accordance with these weights, the amounts of each currency in the revised basket (US dollar, euro, renminbi, yen and pound sterling) will be calculated on Sept. 30.
The weights will be kept unchanged for the next five years.
It was widely expected that market demand for the renminbi or yuan would surge dramatically before the IMF announced its decision to include the currency on Nov. 30 last year.
However, the renminbi dropped to 1.72 percent in global payments in June, the lowest since October 2014. That suggests the Chinese currency is facing some challenges.
The normalization of US interest rates is set to weigh on emerging-market currencies, including the renminbi.
SDR basket users have to adjust their portfolio in accordance with the new basket.
In that sense, IMF member nations will have a US$30.9 billion demand for the Chinese currency given its weight of 10.92 percent in the SDR basket.
Will that reverse the market expectation for another yuan depreciation?
Undoubtedly, global demand for yuan-denominated assets is set to increase in coming years.
The Monetary Authority of Singapore announced on June 22 that it will be including renminbi financial investments as part of its official foreign reserves.
There were around US$94 billion of renminbi assets in global foreign exchange reserves as of end of 2014, about 1 percent of the total reserves, according to IMF data.
The demand for renminbi assets is poised to increase as more central banks hold more of the Chinese currency in their foreign exchange reserves.
Renminbi is expected to represent 7.8 percent of global foreign exchange reserves by 2020. That would translate into 5.7 trillion yuan (US$858.5 billion) demand for renminbi assets by then.
As of the end of June, China’s custody volume of debt amounted to 10.7 trillion yuan. That is far insufficient to meet soaring demand from global investors.
Some believe capital won’t flow into renminbi, and the redback won’t become a safe-haven currency either.
The Chinese currency was quite stable between 2011 and 2015. But it has slipped against traditional safe-haven currencies amid increasing market volatility.
It’s proved that renminbi is less favorable than US dollar, Japanese yen, euro, sterling and Swiss franc during market turmoil.
As such, there’s no strong reason for central banks to increase their renminbi holdings.
Will the renminbi drop sharply? Beijing is likely to keep exchange rates steady before October in order to make a smooth transition into its inclusion in the SDR basket.
The renminbi is unlikely to move dramatically after being included in the basket. Various nations already pledged to avoid competitive currency depreciation in G20 meeting.
China, as the host of this year’s G20 meeting, won’t let yuan dive freely.
The country is responsible for maintaining a stable and transparent exchange policy, which in turn also favors itself.
A weaker renminbi would cause uncertainty and hurt domestic investment and consumption. China’s current economic conditions also do not support a sharp yuan depreciation.
In theory, SDR inclusion will support renminbi in the medium term. It would help promote use and acceptance of renminbi globally as China is playing a bigger role in the world economy.
Many financial institutions both at home and abroad are interested in issuing SDR bonds, which would increase demand for the Chinese currency.
It takes time to develop SDR bond products after the renminbi inclusion, as well as build enough liquidity in the secondary market.
If these SDR bonds are available for mainland investors, who are eager to have foreign exchange exposure, there should be vast potential.
This article appeared in the Hong Kong Economic Journal on Aug. 2.
Translation by Julie Zhu
[Chinese version 中文版]
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