What price will China have to pay to make renminbi an international reserve currency?
Andrew Sheng considers what China will have to do for the yuan to be part of the IMF's currency basket
Bankers and financial centres from Hong Kong to London salivate at the trillions of dollars of new trading that will come from the renminbi becoming a full-fledged reserve currency. But when will it happen?
One milestone of the renminbi becoming a full-fledged reserve currency is to join the club of component currencies of the special drawing rights, created by the International Monetary Fund. Unlike currency issued by central banks, this reserve asset is issued by the IMF to its 188 sovereign members, in exchange for their national currency and other convertible currencies. The special drawing rights can be counted as part of their foreign exchange reserves.
Indeed, member countries may draw on this account if they need more foreign exchange. Normally they may draw up to four times their quota, but the more they draw, the more they will be subject to IMF "conditionality", in the same way your banker imposes more stringent conditions the more you borrow. The Greeks and Asians learnt that when you are subject to an IMF lending programme, you cede quite a lot of national decisions to the IMF, which is why many members shy away from IMF credit.
There are two key criteria for entry - the export criterion and the 'freely usable currency' criterion
The special drawing rights were introduced in 1969 as an international reserve asset to supplement global liquidity. They are not a reserve currency in the sense that the markets trade them and you can put a deposit in any bank denominated in them. They are used mainly by central banks to transact with the IMF. For example, accounts of the IMF and the Bank for International Settlements (the de facto central bank of central banks) are denominated in them.
The special drawing rights comprise a basket of only four currencies - the US dollar, euro, pound sterling and the Japanese yen. Being part of the basket is like joining the gold standard, as the currency is considered a full member of the reserve currency club.
Other than prestige, there are obvious benefits from being a member. Data from the Bank for International Settlements showed that central banks held nearly US$12 trillion (excluding gold) at the end of last year, with the US dollar accounting for 62.9 per cent of the reserves, the euro 22.2 per cent, the pound 3.8 per cent, and the yen 4 per cent. In other words, even though there are many freely usable and fully convertible currencies, such as the Australian dollar, the four components of the special drawing rights account for 92.9 per cent of the total central bank foreign exchange reserves.
In other words, if the renminbi or any other currency joins the club, demand from central banks alone would add to demand for that currency, making it even more usable and tradeable.
But joining any club has conditions. Last week, the IMF published a paper looking at the conditions for including the renminbi. The next decision point for the review is in November, when the IMF executive board meet to review the special drawing rights composition and its valuation.