How the renminbi became an elite currency

The International Monetary Fund (IMF) has decided to add China’s renminbi to its elite basket of global currencies. The move follows a campaign by China for inclusion in the IMF’s special drawing rights (SDR) basket – currently only the US dollar, the British pound, the euro and the yen are included.

The 1 October 2016 date for inclusion marks a major milestone for China as a global economic power and is a vote of confidence in its efforts to become a more market-driven economy.

While China has undoubtedly succeeded in raising the profile of the renminbi in recent years, its march to reserve currency status has not been an entirely smooth journey.

Source: Bloomberg

The renminbi’s growing role in world trade

China is now the world’s largest exporter and is set to overtake the US as the biggest importer. The renminbi’s role has expanded alongside China’s emergence as a leading trading nation and is likely to continue to grow. An HSBC survey of 1,600 executives in 14 different markets in January and February found more than half expect to start using the renminbi more frequently in transactions.

In 2013, the renminbi leapfrogged the euro as the world’s second choice in trade finance after the dollar. It is now the preferred currency for trade between China and regional partners such as South Korea. Trade payments in renminbi to China and Hong Kong now make up almost a third of transactions, compared to just 7% three years ago, according to international payments services provider Swift.

How did the renminbi get SDR status?

The renminbi’s inclusion hinged on meeting two criteria – it needed to be “widely used” and “freely usable”. It met the first criteria because of the currency’s massive role in global trade and increased use outside China’s borders. However, in 2010, the Chinese currency was found not to be freely usable. As recently as July, an IMF report said that the renminbi still had further to go to reach the freely usable criteria.

So what changed?

In recent months, China announced policy reforms to tackle many of the shortcomings highlighted in the IMF report. The decision to include the renminbi was based on its increasing international use, reforms that would allow the currency to be used more easily in SDR operations, and moves by China to improve data disclosure, according to the IMF.

What is the likely impact on the global economy?

Although the renminbi’s inclusion in the SDR may not have an immediate practical impact on the world economy, it is likely to increase global demand for the currency in coming years.

What does it mean for China?

The inclusion is welcome news for China after this summer’s stock market turbulence, slowing growth and the move towards a market-driven exchange rate. It is also an endorsement of China’s economic development and reforms.

Have you also read?

Is a stronger renminbi threatening China’s long term growth?

The rise of the renminbi

The international role of the renminbi

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Author: Rosamond Hutt is a Senior Producer at Formative Content.

Image: A Chinese national flag flutters in front of the headquarters of the People’s Bank of China, China’s central bank, in central Beijing, May 16, 2014. REUTERS/Petar Kujundzic