Basket case

It was a birthday present – of sorts. Confirmation that the renminbi has the new status as a global reserve currency came on October 1 – which is China’s National Day – when the International Monetary Fund officially added it to its basket of Special Drawing Rights (SDR) currencies.

The news was greeted as something worth celebrating by China’s central bank, which described it as a milestone in the internationalisation of the renminbi, and further proof that the financial sector is opening up.

Added as the fifth currency (and the third largest, with an initial weighting of 10.92%), the yuan is the first to join the basket since 1999, when the euro replaced the Deutsche Mark and the franc.

Central bankers use SDRs to buy their domestic currencies from other countries and help to maintain exchange rates. That is pretty arcane stuff for the rest of us, but the changes are a major step forward for the Chinese, whose leaders were unimpressed when their application to be included in the SDR basket was turned down six years ago.

The new era comes at a time in which international usage of the yuan has been declining, primarily because of concerns over depreciation. Data from SWIFT, the financial network that banks use to send payments, shows that its share of worldwide payments in August was 1.86%, substantially down on its peak of 2.8% a year earlier. Offshore deposits have also been shrinking, declining by a third in Hong Kong, the largest clearing centre.

Critics of the IMF’s move say it is undeserved as China’s currency doesn’t meet the body’s criteria of being freely usable and widely adopted. In fact, US Treasury Secretary Jack Lew sounded a similar warning last week that the yuan needs to be more market-driven.

“In my dealings with our counterparts in China, I recognise that they have laid out a reform programme that would get China where it needs to go, but I pressed them very hard that they need to implement that programme to experience the results,” he said.

Supporters say it will prompt the Chinese to move towards international norms, such as the “high transparency standards” demanded of reserve currencies by the IMF.

Nonetheless, the predictions in the Chinese media were that reforms would move forward at a pace of China’s own choosing. Certainly, the yuan’s debut wouldn’t lead to hasty changes in capital controls, warned China Business News in one of the commentaries, pointing out that the yen and the franc were protected long after getting SDR status.

Nor will there be an appreciable shift in official reserves in the shorter term because the world’s central banks aren’t mandated to allocate their holdings in line with the composition of the SDR basket.

An IMF survey has suggested that 38 out of 130 central banks held yuan assets at the end of 2014, or about 1.1% of the total reserve assets held at the time.

More significant, perhaps, is the symbolism of the move as an indicator of increased international interest in yuan-denominated assets, including the opening up of China’s interbank bond markets to institutional investors.

This was one of the points made last month by Paul Mackel, HSBC’s head of emerging market FX research, in a report that focused on the indirect impact of the changes. Over the past few years China has reduced controls over investment in yuan-denominated bonds and a continuation of the changes could see Chinese government bonds included in emerging market indices for the first time. That could push up foreign ownership of China’s sovereign paper to more than three times its current levels.

In this context, the changes on October 1 were important because they show that China is getting more interested in playing by market norms. This should attract further foreign inflows into yuan-denominated assets, making them more liquid, and more attractive to the world’s central banks.

As an example, HSBC notes that the Monetary Authority of Singapore announced in June that it would start to recognise yuan-denominated investments as official reserve assets because it is getting easier to trade them.

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