The International Monetary Fund (IMF) executive board has decided to include the Chinese currency, the yuan, to its Special Drawing Rights (SDR) basket, marking a milestone in the renminbi (RMB) global march and a vote of confidence in China's ongoing financial reforms.
During a meeting on the regular five-yearly review of the SDR basket, the IMF executive board, which represents the fund's 188 members, decided that the RMB "met all existing criteria," the Washington, D.C.-based international lender said in a statement afterwards.
Effective from Oct. 1, 2016, the RMB will be included in the SDR basket as a fifth currency, along with the U.S. dollar, the euro, the Japanese yen and the British pound.
IMF Managing Director Christine Lagarde described the decision as "an important milestone in the integration of the Chinese economy into the global financial system."
"It is also a recognition of the progress that the Chinese authorities have made in the past years in reforming China's monetary and financial systems," she said.
The RMB will have a weighting of 10.92 percent in the new SDR basket, while respective weightings of other currencies in the basket are 41.73 percent for the U.S. dollar, 30.93 percent for the euro, 8.33 percent for the Japanese yen and 8.09 percent for the British pound.
Created by the IMF in 1969, the SDR is an international reserve asset created to supplement its members' official reserves. It can be exchanged among governments for freely usable currencies in times of need.
The long-awaited outcome came as China has been pushing its currency to wider use on the global stage.
The RMB became the world's No. 2 currency for global trade finance in 2013, and overtook the Japanese Yen to become the fourth most-used world payment currency in August, only after the U.S. dollar, the euro and the sterling, according to the global transaction services organization SWIFT.
To meet the IMF "freely usable" criteria, Chinese authorities undertook a series of reforms in recent months, such as improving its foreign exchange rate formation system, opening up its interbank bond and forex markets, and improving data transparency by subscribing to the IMF's Special Data Dissemination Standard (SDDS).
China's central bank, the People's Bank of China (PBOC), announced early Tuesday morning that it welcomes the IMF decision to include the redback in the SDR basket, saying the move shows the IMF's recognition of China's economic development and reform achievements.
"The joining of RMB in the SDR basket means the international community has greater expectations on China to play an active role in the world economic and financial arena," the statement said.
Offshore yuan strengthened sharply on Monday ahead of the decision, with the currency rising 0.4 percent against the U.S. dollar during the trading, marking the biggest gain in a month.
In a muted reaction to the inclusion news, the central parity rate of the yuan weakened on Tuesday by 11 basis points to 6.3973 against the U.S. dollar, according to the China Foreign Exchange Trading System.
"Expectations have already been riding high that the board would formally announce the RMB's inclusion, which implies that a lot of near-term expectations should already be factored into the RMB movement," HSBC said.
The market reached a consensus that immediate yuan demand triggered by the new formula will be negligible due to the limited asset value of total SDR outstanding.
Over the long run, the balance of risk remains tilted toward depreciation, a latest Bloomberg Brief special report commented on the issue.
Membership in the IMF's SDR club might encourage more funds to flow into China, but the capital-account opening that SDR inclusion is intended to catalyze may see even larger quantities of funds flowing out, the report said.
It projected a median forecast for the yuan to end 2015 at 6.4 against the dollar and drop further to 6.6 at the end of 2016.
Wang Tao, a UBS economist, expects a 5 percent depreciation of the yuan against the U.S. dollar in 2016 in a gradual rather than one-off manner.
The Aug. 11 depreciation move, explained by the PBOC as allowing the central parity rate of the yuan to better reflect the market rate, was largely understood by the market as China wishes to have a solid grip on fairly stable exchange rate while maintaining independence on making monetary policies.
While the immediate benefits of the yuan's SDR entry may be limited, economists have looked beyond the symbolic significance of the label to far-reaching implications for China's economic and financial reforms.
"The significance will continue to lie in all the necessary financial reforms and the capital-account opening to achieve a positive outcome and further advance RMB internationalization," Wang said.
Following the IMF decision, China's central bank vowed to speed financial reforms and opening up to make positive contribution to global economic growth, financial stability and economic governance.
In an article published last week on the flagship People's Daily which mainly reflects views from the leadership, central bank governor Zhou Xiaochuan pledged to make the RMB a convertible, freely usable currency when expounding China's financial reform agenda in the next five years.
The senior policy maker, however, warned in the same article against any possible financial attacks or sanctions from overseas in some extreme circumstances.
He expected the share of RMB use in cross-border trade settlement will exceed one third by 2020, and the yuan will become an international currency by that time.
As the regulator grants wider access for foreign financial institutions to the domestic interbank bond market and the onshore interbank foreign exchange market, China also encourages more domestic funds to invest overseas by trying out the scheme of qualified domestic individual investors (QDII) II in big hubs such as Shanghai.
In a press conference on Tuesday, PBOC Vice Governor Yi Gang said the yuan's SDR entry is not the end of the story, adding that China is committed to cementing the yuan's position as a global currency.
Key Efforts in 2015
On July 14, the central bank granted access for foreign central banks, sovereign wealth funds and international financial institutions to the domestic interbank bond market and further opened the onshore interbank foreign exchange market to such institutions on Sept. 30.
On Aug. 11, the PBOC reformed the country's exchange rate formation mechanism to allow the central parity rate of the yuan to better reflect the market rate.
On Oct. 8, the first phase of the Cross-border Interbank Payment System (CIPS), which provides capital settlement and clearing services for cross-border yuan transactions for financial institutions, was launched in Shanghai, promoting the global use of the Chinese currency.
On Oct. 20, the PBOC extended an agreement on a reciprocal currency swap scheme with the Bank of England to promote London as an offshore RMB center. Meanwhile, the PBOC also issued its first offshore RMB note in London.
On Oct. 24, the central bank scraped the ceiling limits on all deposit interest rates, marking the completion of interest rate liberalization.
