The Renminbi still has great potential to become a major currency

This week is the “Golden Week” in China. Beginning on October 1st, the country embarks on a 7-day holiday to celebrate Chinese National Day.

On October 1st 2016, China also celebrated the inclusion of its currency, the Renminbi, as the fifth currency in the Special Drawing Right (SDR) basket.

A year has almost passed since the inclusion was decided in last November’s review conducted by the IMF.

What’s the significance now that it’s all happening?

Renminbi in the SDR

The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves.

The SDR is neither a currency, nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members.

Holders of SDRs can obtain these currencies in exchange for their SDRs in two ways: first, through the arrangement of voluntary exchanges between members; and second, by the IMF designating members with strong external positions to purchase SDRs from members with weak external positions.

The value of the SDR was based on a basket of four major currencies before October this year namely the US dollar, Euro, Japanese Yen, and Pound Sterling.

Effective October 1st 2016, the five currencies in the new SDR basket are weighted as follows:

1. US Dollar 41.73% (compared with 41.9% in the 4-currency basket)

2. Euro 30.93% (previously 37.4%)

3. Chinese Renminbi 10.92%

4. Japanese Yen 8.33 per cent (previously 9.4%)

5. Pound Sterling 8.09 per cent (previously 11.3%)

The last change in the SDR basket dates back to 1999, when the Euro replaced the Deutsche Mark and French Franc.

The significance for China and rest of the world

One criterion for the inclusion in the SDR basket is that the currency has to be freely usable.

The Chinese Renminbi has become the eighth most traded currency since last year.

The IMF has suggested that the inclusion of the Renminbi in the SDR reflects the progress that China has made in reforming its financial systems and liberalising markets.

China has now set up 17 offshore Renminbi clearing houses in the last 4 years: 13 alone in the last two. The latest, in September this year, was in the US.

The Renminbi exploded onto the international scene when the currency dropped by more than 4% during a short period in mid-2015, immediately causing the currencies of other major export economies to follow suit.

Published on interest.co.nz