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Yuan will soon be global

Capital controls will continue to be eased gradually.

After decades relying on revenues from exports to invest at home and generate growth, China wants to move towards a consumption based model. But to do so it needs to find an alternative source of financing. A solution for this problem would be to open up to foreign capital. Instead of obtaining revenues from exports, they could come from investors. The decision is complicated because it implies losing a great share of control over the financial system, but after years of consideration, China decided to go for it, and pursue the goal of internationalising the renminbi, or RMB. As part of the process, China has requested to be included in the basket of "Special Drawing Rights", or SDR currencies. The SDR is an international monetary reserve asset created by the International Monetary Fund, or IMF, whose purpose is to supplement global liquidity and whose value is exclusively based on the four most traded currencies - US dollar, euro, British pound and Japanese yen.
The IMF reviews every five years its SDR composition, the latest being this year. However, the IMF is considering delaying the decision on the RMB's inclusion in the SDR basket to next year, allowing more time for China to meet all the requirements. If the Chinese currency is included, demand for RMB will be boosted, as central banks and investors will feel more comfortable holding the Chinese currency. AXA estimates that as much as 10 per cent of global reserves ($11.6 trillion) would flow into yuan-denominated assets, roughly ten times this year's amount.
The last review was in 2010, when the IMF rejected China's request to have its currency included in the SDR basket on the basis that the RMB was not "freely usable", according to the following indicators: the currency composition of official foreign exchange reserves, international banking liabilities, international debt securities and global forex markets turnovers. The RMB did not meet requirements in all four elements.
Gradually, China made efforts to integrate in the global financial system, particularly after the succession in leadership in 2012. The measures adopted included the setting up of offshore yuan-trading hubs, the launch of the Shanghai-Hong Kong stock connect, the establishment of free-trade zones and the widening of the RMB trading band. These actions resulted in an increase in the international use of the renminbi. Today, the RMB is the second most used currency in trade finance, the fifth for global payments - behind the four currencies that are included in the SDR basket - and the fifth in international banking liabilities. By other metrics, the renminbi remains a small currency, but progress is encouraging: its use for issuance of international debt securities rose from less than 0.1 per cent to 0.4 per cent of the world's debt in five years. In terms of forex markets, renminbi transactions increased from 0.1 per cent to 1.1 per cent. There is one indicator in which the renminbi lags behind: official foreign exchange reserves. Central banks prefer other currencies to keep in their vaults, but that is about to change, partly as a consequence of the efforts listed above. Over 40 central banks have announced that they were planning on holding, or already hold, renminbi assets, in anticipation for the inclusion of the yuan in the SDR basket.
Progress to internationalise the currency came too late for this round of decision making. The G7 and the IMF have praised the evolution of the RMB, but hinted that China is not there yet. In the upcoming several months, we expect China to introduce additional liberalising reforms, with more to follow even if the IMF does not accept the renminbi in the exclusive club of SDR currencies. The latest move took place last week, when the Chinese central bank adopted a new measure that aligns the previous day's spot rate to the next day's reference rate, which led to the depreciation of the currency. International investors should get ready to access the Chinese economy, and to receive Chinese investors into their countries soon.
The writer is an economist at Asiya Investments Company. Views expressed by the author are his own and do not reflect the newspaper's policy.