China's currency, the renminbi (RMB), is breaking the financial world's ultimate glass ceiling and embarking on a new journey towards global reserve status when it formally joins the elite currency club of the International Monetary Fund (IMF) on Saturday.
It is an acknowledgement of the progress China has made to get integrated into a global financial system dominated for decades by advanced economies, marking a historic milestone for China, the IMF and the international monetary system.
Break financial glass ceiling
Christine Lagarde, Managing Director of the IMF, on Friday announced that the renminbi will be considered by the international community as a "freely usable international currency" and will join the IMF's Special Drawing Right (SDR) basket on Oct 1, along with the U.S. dollar, the euro, the Japanese yen and the British pound.
This is "the first time" in history that the SDR basket has expanded, Lagarde said, noting the inclusion of the renminbi into the SDR basket will further diversify it and will make its composition more representative of the global currencies and the global economy.
The SDR is an international reserve asset created by the IMF in 1969 to supplement its member countries'official reserves. It can be exchanged among governments for freely usable currencies in times of need.
As the renminbi meets the IMF's standard of being "freely usable" in the global economic system, the Chinese currency will be used in the IMF's financial operations going forward, Lagarde said.
"There's never before been a currency of emerging markets that is being used for international transactions in the IMF to borrow and lend. This is the first time that has ever happened," Tamim Bayoumi, a senior fellow at the Peterson Institute for International Economics, told Xinhua.
"I think it's a very important signal that the world is coming to terms with growing importance of emerging markets, not only in terms of trade, but also in terms of finance," Bayoumi said. "The renminbi is breaking the financial glass ceiling."
Eswar Prasad, a senior fellow at the Brookings Institution and former head of the IMF's China Division, also agreed that the renminbi's inclusion into SDR basket is "a huge important step" for China and the international financial community.
"It's the first time that the currency of a large and middle-income country is being included in the SDR basket," Prasad told Xinhua, adding it's a testimony to China's growing importance to the global economy and international finance.
The renminbi's inclusion is also "an important step" in the integration of Chinese economy into the global financial and monetary system and it reflects the progress made in reforming China's monetary, foreign exchange, and financial systems, Lagarde said.
New journey towards global reserve status
While gaining the official status of a global reserve currency does not amount to a game-changer in the international financial system, it could prompt central banks around the world to begin adding renminbi-denominated assets to their reserve portfolios. Private investors could also be encouraged to gradually buy more Chinese assets for higher yield rates.
"We expect that the inclusion of the renminbi in the SDR basket will further support the already increasing use and trading of the renminbi internationally," said Siddharth Tiwari, director of the IMF's strategy, policy and review department.
With steady economic growth and higher bond yields, China has seen growing interest overseas in using the renminbi and holding Chinese government bonds, despite a depreciation of the currency against the U.S. dollar in recent months.
The renminbi was the fifth most active currency for global payments by value in July, with a share of 1.9 percent, an increase from 1.72 percent in June, according to data from global transaction services organization SWIFT.
However, the global reserve currency status will not automatically turn the renminbi into a major global reserve currency. That would be the market's choice.
"Ultimately no matter what the IMF or anybody else says, it's the market that will determine how prominent the renminbi is," Prasad said, adding the reserve status for the renminbi will give China "additional momentum" to push for more reforms.
In order to increase the attractiveness of the renminbi as a global reserve currency, he suggested China needs a more open capital account, a more flexible exchange rate, and most importantly, a broad set of financial markets and a better financial regulatory framework.
Jin Zhongxia, IMF executive director for China, said this is "a new starting point" for China's economic reforms and development, adding that China will continue pushing for financial reforms following the renminbi's formal inclusion into the reserve currency basket.
"China will eventually liberalize the capital account to a larger degree, and the exchange rate will become much more flexible," he said, emphasizing it would go through a gradual or evolutionary process.
"We're fully aware that our market-oriented reform efforts are still a work in process, so there is still quite a lot of work to do," he said.
If China undertakes further financial reforms and its economy continues growing as it has been, Prasad predicted the renminbi could account for about 10 to 15 percent of global foreign exchange reserves over the next 10 to 15 years, becoming a severe challenger to the existing reserve currencies such as the Japanese yen or the British pound.
