Taking a correct view on inclusion of China's renminbi in the special drawing right basket

From Oct 1, 2016, the renminbi is officially included in the special drawing right basket.

It is the first time that the currency of an emerging country has been included in the SDR basket, which represents the global community's recognition of China's economic and financial reform, and also the internationalization process of renminbi.

It reflects an emerging economy's valid request to build a more convenient financial environment that fits its own needs for development, and it will also push the current international currency system in a more fair, rational and diversified direction.

So what kind of impact will the inclusion bring to us?

A smooth transition

After approval in Dec 1, 2015, the official inclusion of the currency in the SDR basket took 10 months.

Actually, before China's central bank launched reform of renminbi's central parity rate in August 2015, the International Monetary Fund had already issued a report that proposed to extend the evaluation period to Sept 30, 2016.

The extension of the evaluation period would give China more time to meet the requirements of SDR, and also give more time to the central banks of other countries and sovereign funds to increase their renminbi reserve, so as to make a smooth transition.

Thus, the international market has already allocated renminbi assets, and is likely to sharply increase them. For the same reason, renminbi's use in the global financial market will not increase on a big scale in a short time.

The true value of IMF and SDR is weakening

The key function of the IMF is to use SDR's assets to supplement international capital flows during economic crises or when there is a scarcity in capital flow. But during the 2008 global crisis, many countries and the US Federal Reserve avoided the IMF, the Fed directly exchanging currencies with the central banks of many countries to provide the international flow of US dollars.

This measure has changed the most urgent capital flow supply mechanism of the international currency system during economic crises or capital shortage periods, which weakens the role of IMF.

The IMF and SDR have been further weakened since October 2013, when the Fed signed currency swap agreements, which have no limits in terms of amount and duration, with the central banks of Europe, Britain, Japan, Canada and Switzerland.

Mid and long-term cross-border capital flow is controllable

Now the renminbi has been put into the SDR basket, to diversify their currency reserves, central banks and international organizations will increase demand for renminbi assets. At present, the renminbi assets held by the central banks globally are about 782.2 billion yuan, which equals about $124.1 billion or 1.1 percent of the global currency reserve.

The Japanese yen accounts for about 3 percent of the global currency reserve, and the pound accounts for about 5 percent. If in five to 10 years, renminbi's share in the global currency reserve exceeds that of the yen or the pound and reaches to more than 3 or 5 percent, then demand for renminbi assets will reach $250 billion to $500 billion, and the annual demand will be about $50 billion, which will only have a small impact on transactions in China's foreign currency market, and won't hit hard the cross-border capital flow.

The independence of monetary policy control will be weakened

As the renminbi enters the SDR, the scale of renminbi cross-border and overseas flow will increase continuously, which means that the monetary aggregate will not only be affected by elements domestically, but will also be affected by overseas governments, enterprises and individuals' demands for renminbi. So it will be more difficult for China's central bank to count the renminbi's stock both in China and overseas, and it will also be more difficult and complicated for it to make monetary policies. On the other hand, as cross-border renminbi flows will be on a large scale, China's central bank will have more ability to control the supply of base money and carry out monetary policies.

Domestic economic and financial operation order face challenges

With the renminbi included in the SDR, China's financial system will be more marketized and internationalized, so global economic and financial risks will more easily affect China.

With the renminbi being included in the SDR basket, based on the IMF's request, China's central bank will further reduce its intervention on foreign currency, and will enlarge the fluctuating range of the renminbi exchange rate.

The lagging of the Federal Reserve's interest rate and China's uncertain economic prospects have led to a pessimistic prediction for the renminbi exchange rate in mid and short term, making it fluctuate a lot. This fluctuation will bring exchange rate risk, and will bring a huge risk to China's economic and financial security, possibly even affecting China's economic development.

The author is a researcher of International Monetary Institute, deputy dean of the National Academy of Development and Strategy, Renmin University of China. The views expressed do not necessarily reflect those of China Daily.

(China Daily European Weekly 10/14/2016 page11)