SDR move a milestone in yuan’s internationalization

By Li Wei Source:Global Times Published: 2015-12-2 0:13:01

Decision marks new victory in China’s financial diplomacy after AIIB launch

Illustration: Peter C. Espina/GT

The IMF's Executive Board on Monday voted to include the yuan in the fund's basket of reserve currencies for its Special Drawing Rights (SDR) alongside the dollar, euro, pound sterling and yen. The yuan will hold a 10.9 percent weighting in the basket, higher than the yen's 8.33 percent and sterling's 8.09 percent but below the dollar's 42.9 percent and the euro's 30.93 percent.

The yuan's inclusion, effective from October 1, 2016, is like a financial version of China's WTO entry. It marks another significant victory in China's financial diplomacy following its successful launch of the Asian Infrastructure Investment Bank (AIIB) earlier this year. The yuan's SDR inclusion will have a far-reaching impact on China's opening up and the rise of its financial sector and is likely to reshape the world financial order.

It also marks a milestone in the efforts China has been making since 2009 to internationalize its currency, with its symbolic political impact and the help it will offer technically in boosting the status of the Chinese currency.

 From a political perspective, the SDR inclusion means that the yuan has been recognized by the IMF and international community as the world's fifth reserve currency after the dollar, euro, sterling and yen.

Such official recognition is crucial for the rise of a currency. The dollar's supremacy in the world foreign exchange market was based partly on official recognition of it at the Bretton Woods conference back in 1944. China will become a member of the elite currency club when the yuan is added to the basket. And the countries that issue the five IMF reserve currencies including the yuan will become the "permanent member states" of global financial governance in the future.

Therefore, China will have a greater voice in terms of influencing the institutional system in the international currency arena. Additionally, the SDR inclusion gives the yuan a good credit rating, which is equivalent to a "market passport."

This helps in boosting the international market's confidence in the Chinese currency, as various central banks and institutional investors use the composition of the SDR basket as a reference when it comes to asset allocation.

On top of that, it will give strength to the push for financial liberalization and reform. The opposition built up by vested interest groups against the country's financial opening-up will therefore be effectively overcome. This is because the yuan's inclusion in the SDR basket not only symbolizes new global status and power for the Chinese currency; it also means China will have greater responsibilities in the monetary and financial field, which will require more open and transparent policy. China has been recognized as a financial and monetary power globally, and this means the nation will have to be a contributor to the basis of global financial and monetary stability rather than just a spectator.

However, we must also realize that the SDR inclusion is not by itself a guarantee of success in the yuan's internationalization. In the same way, accession to the WTO did not automatically make China a trade giant.

Currently, only 1.1 percent of global foreign exchange reserves are denominated in the yuan. Even if the figure rises to 5 percent in the next decade, the yuan's share in global currency reserves would just exceed that of sterling and the yen, while remaining far behind the euro with a share of 25 percent and the US dollar with a 60 percent share.

The yuan's status as a major global currency will ultimately be verified by the market, which will take into account multiple factors such as the Chinese economy's growth prospects, the expansion of China's financial market, the reliability of its monetary policy and also the country's political stability.

The author is an associate professor with the School of International Studies at the Renmin University of China. He is also a research fellow at the National Academy of Development and Strategy at the Renmin University of China.

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