Speeding financial reforms pave way for yuan's SDR entry

China's financial reforms have raised the possibility of yuan's (RMB) inclusion in the IMF Special Drawing Rights (SDR) basket.

In a recent meeting with IMF Managing Director Christine Lagarde, Chinese Premier Li Keqiang reiterated his hopes for the yuan, promising to play an active role in maintaining international financial stability.

Created by the IMF in 1969, the SDR is an international foreign exchange reserve asset comprised of a weighted basket of four currencies -- U.S. dollar (41.9 percent), euro (37.4 percent), British pound (11.3 percent) and Japanese yen (9.4 percent).

Allocated to IMF members on the basis of their contribution to the fund, an SDR represents a claim to foreign currencies for which it may be exchanged in times of need.

The value of a country's total exports and imports, as well as whether a currency is fully convertible under the capital account, are taken as two key criteria for SDR entry.

The IMF reviews the currencies in the SDR basket every five years. At the last SDR review in 2010, the yuan met the first criterion, but was assessed as not meeting the "freely usable" criterion.

Since then, there has been serious progress on widening the global reach of the currency: expanding investment quotas, increased cross-border settlement, and the launch of the Hong Kong-Shanghai Stock Connect scheme.

The RMB became the world's No. 2 currency for trade finance globally in 2013, and overtook the Canadian and Australian dollars to enter the top five world payment currencies last year, according to global transaction services organization SWIFT.

THe RMB has also been used as a reserve currency in some other countries outside China.

While meeting delegates at the China Development Forum, central bank governor Zhou Xiaochuan pledged to accelerate reform and opening up of its capital market in 2015, with an aim to make the Chinese yuan convertible on the capital account.

The rules on two-way cross-border investment by individuals will be eased and the capital markets made more friendly to cross-border fund-raising.

"The comment demonstrated Beijing's strong commitment to accelerate financial reforms and achieve full capital account convertibility in 2015, which should increase the chance for the RMB to be included in the IMF SDR basket in the forthcoming review," noted a report from HSBC global research.

BofA Merrill Lynch global research estimated the potential weighting of yuan in the basket at approximately 13 percent.

"We believe the RMB's SDR entry and official status as a reserve currency would further legitimize and accelerate its acceptance as an investment destination for foreign investors," the report said.

This will not necessarily translate into direct yuan appreciation as it will be accompanied by a liberalization of domestic capital outflows, it added.