IMF set to add Chinese yuan to SDR currency basket

China’s currency, the yuan seems to be on track to be included in the International Monetary Fund‘s benchmark currency basket, putting it on par with the dollar, euro and pound sterling.

A draft report by IMF staff who have been assessing the yuan’s technical criteria seems to be favourable.

Three people who had been briefed on the IMF discussions, said a draft report reached a favourable conclusion on including the yuan. “Everything is on course technically and there is no obvious political obstacle. The report leans clearly towards including the RMB in the [basket] but leaves the decision for the board,” one of the officials told Reuters. “There is no real discussion, no obstacles, all seems on course,” another IMF official said.

A positive review by IMF staff will lower the hurdle for board approval as a 70% voting majority is needed rather than the 85% which is normally set for tough decisions. The IMF’s executive board is currently reviewing the Special Drawing Right (SDR), an international reserve comprising the major currencies – the euro, Japanese yen, pound sterling and the dollar.

The SDR composition is reviewed every five years. There have been suggestions that China’s central bank has been aggressively trying to ensure that the yuan makes it to the basket in the current review.

The review was scheduled to take place in November this year. However, the IMF has said that it is extending the SDR valuation basket by nine months from 31 December, 2015 to 30 September 2016, effectively deferring the widely-anticipated addition of the yuan to the basket.

The fund had said that the proposal for the extension was put forward by its staff in a paper published in August. The extension paper was submitted to the executive board for review. In its statement it said the extension would give users, among others, sufficient time to adjust in the event of an addition of a new currency to the basket.

Joining the SDR could not only boost the yuan’s international recognition and the use of the currency globally, it is also expected to lift China’s financial power. The move is also seen as Beijing’s long-term goal of reducing its dependence on the dollar and to place the world’s second largest economy as a serious economic power in the international arena.

So how hard is it going to be to get a Yes vote?

Eswar Prasad, a professor at Cornell University and former head of IMF China Division said: “I think it will be very difficult for the IMF, especially given all that China has done this year, to deny China the prize it really wants,” he said. France and the UK have backed the move and Germany and Italy are among several who have said they are open to the move, depending on whether the yuan meets the technical criteria. The US is believed to have given conditional support for the yuan joining the SDR.

China recently rolled out a series of reforms to liberalise its markets in a bid to help the yuan meet the criterion of being “freely usable” or widely used to make international payments and traded on foreign exchange markets. On Friday, China’s central bank announced that it was freeing the interest rate market by scrapping a ceiling on deposit rates.

That is not all. China has started the weekly issue of three-month Treasury bills and plans to extend yuan trading hours to overlap with Europe. All these add to the tick boxes in the checklist of the technical criteria.

Implications of yuan inclusion

Since the last SDR review, the global use of yuan has increased dramatically. It has become the fourth most-used currency in global payments with a 2.79% share in August, surpassing the yen, according to the Society for Worldwide Interbank Financial Telecommunication or Swift.

Bloomberg noted that adding the yuan to the SDR may also “help the IMF improve its standing with the Chinese”. It said China and other emerging markets were supposed to gain greater representation in the IMF under reforms agreed in 2010 but the US Congress has yet to ratify the changes.

So what will happen when the yuan is placed in the SDR? According to Standard Chartered PLC and AXA Investment Managers, a least $1tn of global reserves are expected to migrate to Chinese assets. And foreign companies’ issuance of yuan-denominated securities in China, known as panda bonds, could surpass $50bn in the next five years, according to World Bank’s International Finance Corp.

“Once the Chinese yuan becomes part of the SDR, a central-bank reserve managers and institutional investors will automatically want to accumulate yuan-denominated assets,” Hua Jingdong, vice president and treasurer at IFC said. “It will be strategically important for China to welcome all kinds of issuers to become regular issuers in China’s onshore market.”

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