China's Yuan / Renminbi a step closer to SDR status ..... so what ?

Tuesday 17th November 2015

China's Yuan / Renminbi a step closer to SDR status ..... so what ?

 Ref :- "The renminbi receives a symbolic seal of approval", The Financial Times, Editorial / investopedia.com

A quick recap :  what exactly are SDRs , or Special Drawing Rights ?

In 1969 the International Monetary Fund (IMF), concerned by the limitations of gold and the US dollar as the sole means of settling international accounts, created SDRs as a monetary reserve currency to be held by individual member countries alongside its existing foreign currency reserves.

It should be thought of an artificial or quasi-currency, made up of a basket of currencies consisting of the US dollar, the Euro, Japanese yen and UK sterling. (Note : in its original incarnation it comprised of 16 currencies, some of which might raise a few eyebrows amongst modern-day observers  --  the Iranian real, for example).

On Friday came the news that staff at the IMF are to recommend to their governing board that the Chinese authorities are well on their way to meeting the criteria required for the yuan / renminbi to become a constituent part of the SDR (i.e. that it's "freely usable"), and consequently it is almost guaranteed that the board will give its approval at its upcoming meeting. Such a step would be a significant victory for China politically, and would certainly boost its claim that its currency deserves the status of a global reserve asset. You might not be totally surprised to hear however that in practice things won't be that simple

However welcome the respectability associated with becoming a member of such an exclusive club may be, China will know that the SDR is an obscure and arcane class of reserve asset created by the IMF and is of use largely as an accounting device. To make more practical and direct use of SDR assets, they first have to be converted back to their constituent currencies to be workable  --  hardly ideal if a central bank is getting its resources together for intervention in FX markets, for example.

Central banks can pick and choose whichever currencies they like to hold as official reserves, and they certainly don't have to be in the SDR basket  --  just think of the widely-held Swiss Franc. Nor does being in the SDR guarantee that a particular currency will automatically be in demand as a reserve asset. In order to achieve that goal, China will have to go further than it has so far by creating large amounts of its currency and being prepared to see it go abroad. Given its predilection for keeping tight control of capital flows and a presumed fear of large balance of payments deficits, Beijing may have to work hard to convince those that matter that they are committed to this course of action.

For the IMF to signal that it is happy enough with the progress that China has made for the yuan / renminbi to be included in the make-up of the SDR is one thing ..... for central bankers around the world to fully embrace it as a reserve asset is something else entirely. For that to happen, they will need to see a continuation of the liberalisation of the currency and of capital controls, and of deregulation generally.

For all their efforts recently, it plainly does not come easily to the Chinese authorities to cede control and they may decide that they've done enough of that for the time being. If that proves to be the case the yuan / renminbi is not about to become the vogue reserve asset , notwithstanding its status as a SDR constituent. But on balance it is reasonable to hope that such a status will encourage further deregulation, and that the currency might be in great demand as a reserve asset in the future. 

For now though, central bankers will ignore political considerations and will look to see China establish a competent monetary and financial track record  --  and that takes time, so don't expect the announcement of the IMF's decision to be accompanied by any great fireworks.